28 Nov Tax Treatment of a Reverse Mortgage
A reverse mortgage is generally a loan where a lender pays a lump sum, a monthly advance, a line of credit, or a combination of all three to you while you continue to live in your home and retain title to it. Plans vary but for the most part a reverse mortgage becomes due with interest when you move, sell your home, reach the end of a loan period, or get baptized into eternal life.
According to the IRS “because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it.”
Where many taxpayers get confused or duped by aggressive salesmen is that the mortgage interest deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Part II of Publication 936, Home Mortgage Interest Deduction. Basically the IRS limits treatment of reverse mortgage loans by allowing as a deductible interest expense on IRS Form 1040 Schedule A the amount of interest paid on up to a $100,000 mortgage debt threshold.
If a reverse mortgage is repaid by a descendant’s estate, the principal and interest accrued to the date of death are deductible on the estate tax return IRS Form 706 as a debt of the estate according to IRC Sec. 2053(a)(4). It is not deductible on the estate’s IRS Form 1041, because it is not an administrative expense of the estate.
If taxpayers who acquire property subject to a liability from a decedent pay off the interest on a reverse mortgage after the borrower dies, they can claim the interest in the year that they pay it, as a “deduction in respect of a decedent” under §691(b).