What You Need to Know About Reverse Mortgages and Taxes
By: Courtney Jorstad
February 5, 2023 • 4 minute read
A reverse mortgage is a great option for tapping into your home’s equity in your retirement. It allows homeowners to eliminate their current monthly mortgage payments and potentially increase their monthly income at the same time.
Since reverse mortgage loans can include additional income and interest on money borrowed, you may have questions about the tax implications.
In this article, we will cover everything you need to know about reverse mortgages and taxes.
Reverse Mortgages and Taxes
What is a Reverse Mortgage?
Before diving into reverse mortgages and taxes, let’s first discuss what a reverse mortgage is and who it is for.
The most common type of reverse mortgage is the Home Equity Conversion Mortgage (HECM), which is insured by the Federal Housing Administration (FHA).
A HECM reverse mortgage is a loan just like a traditional mortgage, but it comes with some very specific qualifications that are different from a forward mortgage.
In order to qualify, you must meet the following reverse mortgage requirements:
- At least one homeowner must be 62 or older
- The home must be your primary residence
- The home must be in good, maintained condition
- You typically need to have a minimum of 50% equity, but qualifying is primarily based on your age and equity you have in your home
- The home needs to be a single-family home, two to four multi-family unit in which you occupy one of the units, or be one of the other approved property types
- The homeowners must complete a counseling session with a counselor approved by the U.S. Department of Housing and Urban Development (HUD)
When homeowners take out a reverse mortgage, it will replace their current mortgage, which means that it will eliminate the monthly payments that go along with it. For any remaining equity, homeowners have the option to receive the funds as a lump sum, a line of credit, monthly payments, or a combination of the three.
Who Owns the House in a Reverse Mortgage?
Some people mistakenly believe that the bank owns the home in a reverse mortgage, but this is not the case.
Just like with a traditional mortgage, the homeowners still own the home with a reverse mortgage, and they are still responsible for taking care of the home.
Who Pays the Property Taxes on a Reverse Mortgage?
Since the homeowners still own the home, they must continue to pay for the maintenance of the home, homeowner’s insurance, and property taxes.
With a reverse mortgage, that also means the home risks foreclosure if the homeowners fall behind on homeowners’ insurance, property taxes, homeowners’ association fees, or fail to maintain the home.
Does a Reverse Mortgage Count as Income?
In most cases, homeowners who take out a reverse mortgage receive their funds as a lump sum, a line of credit, or monthly payments to supplement their income.
However, a reverse mortgage is a loan, which means it is not technically considered income by the Internal Revenue Service (IRS) since it will need to be paid back.
Is Money from a Reverse Mortgage Taxable?
Since the funds that homeowners receive from a reverse mortgage is not technically income, it is not taxable.
Is Reverse Mortgage Interest Tax Deductible?
When it comes time to pay taxes, traditional mortgages allow homeowners to write off the interest they pay on their mortgage through the mortgage interest deduction.
Since reverse mortgages do not require borrowers to make monthly mortgage payments or interest payments, homeowners will no longer be able to take advantage of this deduction until they pay back the loan.
However, reverse mortgage borrowers may be able to take advantage of a tax deduction that is part of the Tax Cuts and Jobs Act (TCJA) that became law in 2017. The TCJA allows homeowners to deduct interest paid on home equity loans if the funds are used on home improvements.
How Capital Gains Taxes May Affect a Reverse Mortgage
Capital Gains taxes are not typically owed on a primary residence, but there is a unique way they can affect those with reverse mortgages. This is actually related to one of the protections that comes with a reverse mortgage.
Since reverse mortgages are backed by the FHA, this means that you will never owe more on the home than what it is worth. If you do owe more, that additional amount is forgiven debt. The IRS categorizes forgiven debt as income since it’s money that does not have to be paid back.
Borrowers will have to pay capital gains taxes on the amount that is forgiven.
If you have more questions about reverse mortgages, we have you covered. Check out our complete guide on reverse mortgages by going here.
If you are ready to move forward, check out our list of recommended reverse mortgage lenders here.