‘Tis the season for taxes! Are you fully prepared for Tax Day? April 18 will be here before you know it…
Taxes are notoriously complicated and nuanced, so it’s natural to have questions, especially when making a major financial decision. Every year during tax season, our team at Longbridge Financial receives an influx of questions from both our customers and business partners alike about how taxes can be impacted by a reverse mortgage.
Are you considering using a reverse mortgage to help you live a more financially secure retirement? Or are you already a borrower who is enjoying greater peace of mind? In either case, you may have your own questions about the tax implications of the loan.
With his in mind, we’ve gathered some of the top reverse mortgage tax-related questions and their answers. These are a great starting point for those exploring reverse mortgage, but we always recommend you consult your CPA or tax professional before making any major financial decisions.
Back to Basics
Before we dive into tax-specific details, let’s cover some reverse mortgage basics. Reverse mortgage loans, specifically designed for homeowners aged 62 and above, work by allowing eligible homeowners to convert a portion of their home’s equity into cash without having to sell the home or make regular monthly mortgage payments.1 Unlike a traditional mortgage where the borrower starts making payments on the loan immediately, reverse mortgage borrowers do not have to repay funds received until after the final borrower no longer lives in the home.
Reverse mortgage loan proceeds can be used however you choose: pay bills, make home modifications, or save up for emergency expenses. Another common way you can use their reverse mortgage proceeds is to reduce your taxable income. Using income tax-free2 reverse mortgage funds to cover expenses and avoid taking any taxable withdrawals from a 401(k) or other retirement plan can allow you to decrease taxable income. This can also help your retirement accounts continue to grow as you continue to delay drawing funds.
Dive Into the Details
It’s important to consider all the ways reverse mortgage loans can impact your finances, so in the spirit of tax season, let’s talk through some of the top tax-related questions and answers about reverse mortgages that you need to know:
Q: Do reverse mortgage proceeds count as income?
A: Simply put, no. While reverse mortgage proceeds can be considered an income supplement in retirement, the Internal Revenue Service (IRS) does not classify loan proceeds – of any kind – as income.2 This means that the funds received from a reverse mortgage are not taxable as income because they are simply a loan advance.3
Q: Is reverse mortgage interest tax deductible?
A: Like a traditional mortgage, some of the costs incurred when getting a reverse mortgage are tax deductible. An example of costs that can be claimed are reverse mortgage origination fees and any broker fees. In addition, any interest payments you make are also tax deductible.
Reverse mortgage interest can be deducted only if the money was used to buy, build, or substantially improve the home.4 For example, if you used the loan proceeds to remodel a bathroom, you could deduct the interest, but only when you eventually pay off the loan. Alternatively, if you use the funds to pay for basic living expenses or medical bills, you cannot deduct the interest.
Q: Will I receive a Form 1098 (mortgage interest statement) from my lender?
A: If you make payments on your mortgage interest totaling $600 or more in a tax year, the lender is required to mail you a Form 1098.5 Most reverse mortgage loans do not require borrowers to make prepayments that equal $600 in mortgage interest paid back, thus the 1098 does not apply in most cases.
With that said, due to the recent refinancing boom, reverse mortgages that have been paid in full are highly likely to have exceeded $600 in interest paid, therefore requiring a 1098. If this applies to you, your 1098 should have been mailed by now. Not sure? Reach out to your lender or tax professional directly to find out.
The mortgage interest deduction is an itemized deduction and must be itemized on Schedule A and submitted with your Form 1040 tax return when you file.6 You can’t claim the standard deduction for your filing status if you elect to itemize, so this could mean paying tax on more income than you have to, if the total of your itemized deductions doesn’t exceed the standard deduction you’re entitled to for the year.
Q: Can my government benefits be affected?
A: Because reverse mortgage proceeds are not considered income by the IRS, Social Security and Medicare benefits generally won’t be affected as they are not needs-based programs. However, loan proceeds are considered an asset for needs-based benefits, like Medicaid, and could potentially disqualify you if you don’t spend the money in the month you receive it.7 We recommend contacting your financial advisor to discuss the potential impact (if any) on your government benefits.
Q: Could I owe capital gains taxes?
A: Capital gains taxes are typically owed on the profits of the sale of an investment. If the investment is a principal residence, the IRS offers a special exclusion. You can exclude up to $250,000 (or $500,000 if you’re married and filing jointly) of capital gains if you have owned and lived in the home for at least two of the last five years.8
With a reverse mortgage, capital gains are less simple. Because a borrower or heirs can’t owe more than the home is worth, when the reverse mortgage becomes due, if the loan balance is greater than the home’s sale price, the difference is forgiven.9 However, that difference will count as additional sale proceeds at tax time.
Q: What about property taxes?
A: Like any mortgage, with a reverse mortgage, you are responsible for property taxes, homeowners insurance, and home maintenance. To ensure you can meet these responsibilities, the Federal Housing Administration (FHA) requires you to complete a financial assessment designed to determine your ability to fulfill all obligations prior to obtaining the loan.
For those who may have limited income or bruised credit, loan insurance in the form of a Life Expectancy Set-Aside (LESA) may be required. A LESA is a pool of funds withheld from the total available reverse mortgage proceeds specifically to pay for property taxes and insurance charges throughout the estimated life of the loan, similar to a traditional mortgage escrow account. LESA funds are set aside are not subject to interest or mortgage insurance premiums until they’ve been paid toward your property insurance and taxes.
Let’s review some of the main take aways from our FAQs! Like any loan, proceeds from a reverse mortgage are not subject to income tax, however, other types of taxes can come due. While they are not considered income, reverse mortgage loan proceeds are considered an asset when it comes to Medicaid and other needs-based programs. Because each borrower’s case is unique, it’s always best to consult your own CPA or tax professional to learn how your own taxes may be impacted.
With the recent lending limit increase and other economic trends in mind, now might be the perfect time to see if a reverse mortgage loan is the right move for your retirement. At Longbridge Financial, our team of experts is ready to help! We’re committed to only recommending a reverse mortgage if it’s the right fit for your retirement.
We know every individual scenario is unique, so we’ll take the time to get to know you and your financial goals as we review your options. Rest assured, if we ever feel that a reverse mortgage is not right for you, we’ll tell you. Not all lenders make this pledge. To get started, contact our team today!