Is reverse mortgage interest tax deductible?

The tax-deductible status of reverse mortgages can be a tricky thing to figure out, as the answer relies on several factors. Indeed, it is a question that doesn't really seem to have a single answer, since reverse mortgages are a rather unique form of loan (in that, the typical borrower tends to be advanced in age and is not expected to pay the balance of the loan within his/her lifetime).

One major difference between reverse mortgages and conventional mortgages is their tax deduction eligibility. With a conventional mortgage, the interest accrued is tax-deductible on an annual basis, so when you file your taxes you can write off that interest. With a reverse mortgage, you cannot deduct your accrued interest until the loan matures. Reverse mortgages, according to the IRS, are not counted as income but rather as a loan advance. Therefore, there is a tradeoff: you owe taxes on your interest but your loan is not taxable income. It can be deducted once the interest is being paid, but the unique situation of reverse mortgages makes that slightly tricky.

There are other factors to consider as well. Reverse mortgage debt is treated in the same manner as home equity debt, according to the IRS. This is important because there is a limit of $100,000 on the principle of tax-deductible home equity debt. The tax on whatever reverse mortgage proceeds exceeding this limit will still be owed by the homeowner.

As mentioned earlier, reverse mortgages are an option most frequently utilized by the elderly, and the balance of the loan is typically not their responsibility. What this means is that the balance comes due after the death of the borrower, and that it will become the responsibility of their heirs (assuming there is anyone to inherit) to settle this debt. As such, the tax situation becomes even more complicated, as estate taxes become a factor.

It should be noted that the fees and costs associated with procuring the reverse mortgage are tax-deductible, so it is important to retain all documents associated with this process for this purpose.

The short answer to your question is yes; the interest on a reverse mortgage is tax deductible.The long answer, however, is that figuring out how much you can deduct and, more importantly, when you can take your deduction is quite complicated and depends on a few important factors.

Before we get to that, it’s important that you have a firm understanding of what exactly a reverse mortgages is.A reverse mortgage is a type of equity loan, usually taken out by someone 62 years or older, who owns their home outright or only has a small mortgage balance remaining.Even though they are the ones taking out the loan, in most cases they will not be the ones repaying it, since the loan comes due when the original home owner dies, sells their home, or moves their place of residence.

When you can deduct the interest on a reverse mortgage depends on when one of these aforementioned events takes place.Since the loan is usually repaid in a single transaction, this means that you will be deducting the full amount of the interest on the loan during a single calendar year, even though you will be charged interest during every year you had the loan.This might sound like a rip-off, but it’s balanced out a bit by the fact that the IRS does not tax the income from a reverse mortgage.

The next major complication is that the IRS considers reverse mortgage debt to be ‘home equity loan debt’ which has restrictions of its own.Most importantly, you can only deduct interest from the first $100k of home equity loan debt if you use the loan for anything other than home improvement.This is not a serious issue for a home equity loan since most are for less than $100k, but since many reverse mortgages cover the full value of a home, you might lose some of your deduction.

Sometimes home owners choose to make payments on their reverse mortgages ahead of time, in hopes of lowering their balance.In this rare circumstance, they will be able to deduct interest during the same tax year as they made their payment; however, this is not as straightforward as in a conventional mortgage.Since home owners usually choose to do this later in the life of a reverse mortgage, many years of mortgage insurance premiums and servicing fees will have accrued on top of the principal and interest from the original reverse mortgage.Your payments will go towards all those years’ worth of insurance and fees before touching the interest and principal on your loan, meaning you will not be able to deduct anything, since you have not repaid any interest.Usually a borrower will have to make substantial payments before they begin paying down the interest of their loan.

Finally, estate taxes are another tax complication for reverse mortgage borrowers. Most reverse mortgages end when the original home owner passes away, leaving their heirs to sort out the taxes stemming from their home.This is usually complicated enough to require professional help.That’s why in many cases an attorney or tax professional will be the one responsible for determining exactly what you can and can’t deduct.