Reverse Mortgages and Taxes

older couple_reverse mortgages and taxes

Some of the most common questions people have about reverse mortgages involve taxes. This is sometimes a confusing topic since a reverse mortgage can generate funds for the homeowner. And homeownership involves property taxes. 

Here’s a brief overview of how a reverse mortgage could impact tax bill. To get in-depth answers about your specific situation, speak with a tax planning professional.

How Does a Reverse Mortgage Work?

A reverse mortgage is a special type of home loan that allows homeowners who are typically 62 years old or older to tap into the equity they’ve built up over the years. It’s called a “reverse mortgage” because the lender pays the owner, either in a lump sum, a monthly amount, through a line of credit, or a combination of the three. Borrowers must meet all loan obligations to stay in good standing.

The way the loan is paid back is different than with a traditional mortgage. When the borrower sells the home, permanently moves, or passes away, or the loan is no longer in good standing, the mortgage is paid off, typically through the sale of the home.

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How Does a Reverse Mortgage Impact Taxes?

In some cases, homeowners with a traditional mortgage can deduct the interest on their annual tax return. However, with a reverse mortgage, the interest accrues and isn’t deductible until it’s paid. That happens when the loan is paid off. If the reverse mortgage isn’t paid until the borrower dies, they will not benefit from a tax deduction.

Are Reverse Mortgage Disbursements Taxable? 

While the homeowner uses funds generated from a reverse mortgage as income, it is usually not taxed like typical income. The government considers the money to be loan proceeds, like money you might receive through a home equity loan or line of credit, or personal loan. As a result, it’s typically not taxable.

What Taxes Do I Need to Pay with a Reverse Mortgage?

Whether you have a traditional mortgage, a reverse mortgage, or a fully paid-off house, you will still need to pay property taxes. In fact, one of the stipulations for a reverse mortgage is that the homeowner must pay their property taxes and homeowners’ insurance on time. You will make direct payments to your tax authority. If needed, the reverse mortgage lender can set aside some of your loan proceeds to help you cover your property taxes.

Other Tax Implications from a Reverse Mortgage

One final tax implication from a reverse mortgage could be capital gains that are paid when you sell an asset, such as real estate. Depending on how long you owned the home, you could owe taxes on the difference between the purchase and sales price. 

If you have questions about reverse mortgages and taxes, it’s a good idea to reach out to your tax professional.