Are Reverse Mortgages a Good Tax Strategy?

Are Reverse Mortgages a Good Tax Strategy? Reverse mortgages are becoming increasing popular – especially for older people who want to tap the equity in their homes. They can provide a convenient source of financing for seniors who are “home rich but cash poor.”

Qualified individuals can keep control of their principal residences while converting some of the equity in the property into cash. Seniors often cannot qualify for conventional “forward” home equity mortgages due to low income, which is one reason why a reverse mortgage might be a good alternative.

But before signing on the dotted line, it’s important to understand the tax consequences.

Common question: With a reverse mortgage, is the mortgage interest deductible on the homeowner’s federal tax return?

Answer: Yes and no. The first $100,000 of reverse mortgage principal will most likely meet the tax-law definition of home equity debt. Therefore, the borrower can generally claim itemized deductions for interest on up to $100,000 worth of reverse mortgage loan principal.

(If the homeowner is subject to the alternative minimum tax, however, the write-off may be disallowed.)

Here’s the problem: The interest cannot be deducted until it’s actually paid in cash, as opposed to being added to the reverse mortgage loan principal. Because of the way most reverse mortgages work, payment in cash may not occur until long after the loan is taken out, assuming all the accrued interest is in fact tacked onto the loan principal. (See right-hand box to understand how reverse mortgages work.)

To summarize, no current federal income tax deduction is allowed for interest that is added to the reverse mortgage loan principal, since the homeowner is accruing – but not paying – mortgage interest at this point. If a current tax advantage is an important factor in the homeowner’s decision to obtain a reverse mortgage, this may not be the right choice.(IRS Revenue Ruling 80‑248.)

Even so, a reverse mortgage can make good financial sense in the right circumstances. Contact your tax adviser if you have questions or want more information to find out the right answer for you.  Are Reverse Mortgages a Good Tax Strategy?