I think a large portion of my posts begin with some variation of the phrase, “There is a great deal of confusion surrounding aspect xx of reverse mortgages.” While this certainly speaks to a lack of originality in my part, let’s face it, reverse mortgages are complicated. There are a lot of aspects which seem superficially similar to conventional mortgages, but are actually quite different. Reverse mortgage interest is one such aspect.

It’s not the the calculation of reverse mortgage interest which is complicated. Just like any other loan, interest is calculated on the outstanding balance of the loan. Whether you take the proceeds from a reverse mortgage as an upfront payment or in installments, interest charges will be calculated monthly based primarily on the amount of money that has been withdrawn to date. However, since you aren’t expect to make payments (interest or otherwise) to the lender with a reverse mortgage during the life of the loan, the loan balance will actually increase over time, such that you are not only paying interest on the principal, but also on the accrued interest. In this sense, a reverse mortgage can be thought of as a kind of negatively amortizing mortgage.

When it comes to the issue of tax deductibility, things get a little hairy. Unlike a conventional mortgage, the accrued interest associated with a reverse mortgage is not tax-deductible on an annual basis. Thus, while you can write off all (in most cases) of the interest on your conventional mortgage when you file your taxes every April, you can’t include interest on your reverse mortgage.

Instead, reverse mortgage interest can only be deducted when the loan matures. 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, which is usually when you pay off the loan in full.” Thus, the IRS feels that since it has been kind enough not to tax you on the proceeds you receive under your reverse mortgage, borrowers then don’t have any grounds for complaint when it comes to not being able to deduct the interest.

If you drill even deeper, however, into the abyss that is the US tax code, you will learn that IRS treats reverse mortgage proceeds as home equity debt, rather than conventional mortgage debt. While this distinction might sound trivial, it actually has serious implications. That’s because the IRS limits the amount of tax-deductible home equity debt to $100,000. Interest on any proceeds that you receive(d) in excess of that threshold, cannot be deducted.

It gets even more complicated when you consider that reverse mortgages are ultimately repaid not by the borrower (assuming he has passed away when the loan “matures”), but by his heirs. This introduces estate tax issues into the equation. Unfortunately, this is beyond my personal expertise, and anyone who ultimately wishes to minimize the tax burden associated with the repayment of a reverse mortgage is encouraged to consult a tax specialist. A financial planner might also be able to make some suggestions about some of the products (insurance and otherwise) which are designed to similar ends.

4 Responses to “Is Reverse Mortgage Interest Tax-Deductible?”

  1. ken solstad Says:

    I’ve found people are surprised by this but cannot figure out why. Seems pretty straight forward. Thanks.

  2. Robert Lally Says:

    It is not straightforward and the IRS published positon may not be technically correct. The Rev. Rul on this is from 1980. IRC 1272 and 163 were cahnged in 1982 to add the OID rules. I see no technical reason why and reverse mortgage is not an OID instrument. as such the intereest accrues. Teh IRS should nopt get it both ways/. Either the nasty OID rules applyu to indidivudals ( which they clearly do) or they do not. The IRS should not get to cherry pick when it likes them.

  3. Erin Kaye Says:

    First of all, if the taxpayer chooses to make payments against the interest on a reverse mortgage, those interest payments would be deductible assuming the other requirements for deductibility are met. A taxpayer aged 62 or over who believes s/he may have difficulty obtaining a regular mortgage might opt to take a reverse mortgage but keep making payments.

    Secondly, IRS publication 936 also states that the amount borrowed under a refinancing representing original acquisition debt is deductible subject to the acquisition debt limit of $1MM, and only the excess is subject to the $100K limit for home equity debt. So if the taxpayer has outstanding acquisition debt at the time the reverse mortgage is taken out, the interest paid on the portion of the reverse mortgage attributable to the payoff of the acquisition debt would be fully deductible and so would interest paid on the excess of the reverse mortgage over the refinanced amount.

  4. Erin Kaye Says:

    Oops, the last sentence above should read “So if the taxpayer has outstanding acquisition debt at the time the reverse mortgage is taken out, the interest paid on the portion of the reverse mortgage attributable to the payoff of the acquisition debt would be fully deductible and so would interest paid on the first $100K of the reverse mortgage in excess of the refinanced amount.”

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