The borrower’s health appeared to be failing. He had life insurance, but could not afford or get underwritten for long-term care insurance. His younger and healthier wife was prepared to be his caregiver. The borrower’s concern was for his wife… who would pay for and care for her if she needed the same help after he had died?

The solution was to self-fund her potential long-term care through a reverse mortgage, but taking no income or withdrawals, and repaying the financed closing costs back over a period of a few years to return the Line of Credit to the original Principal Limit. That plus the remaining Life Insurance death benefit would cover most scenarios.

Although we’ve seen restrictions on cross-selling financial instruments funded by a reverse mortgage, this used a reverse mortgage for one of its original purposes. It accomplished an ‘inter-disciplinary’ planning goal with no other financial instrument required besides yielding a temporary potential tax deduction in the meantime.

In the next segment of this article, what constitutes and does not constitute deductible interest will be lightly explored. For those who refinance, the amount of interest that can be deducted is a combination of the concept you discuss and the IRS references in Publication 554. Neither is complete without the other.

For those who take full advantage of HECMs for purchase, there should be little, if any, limitation on the deductibility of interest. However, there is a theory in the IRS that is gaining acceptance that the interest that accrues on previously accrued interest should not be eligible for classification as interest on Acquistion Indebtedness. This “war” is gaining steaam with other negatively amortized loan products but if accepted, will drop on reverse mortgages like an anvil.

For too long the RM industry has all but completely ignored the IRS and its interests. It is pleasing to see that after speaking in February 2007 on the Learn While U Lunch program and then again at the NRMLA Convention in 2007 on the “Tax Implications of RMs to Borrowers”, NYU now offers a program on reverse mortgages with a strong tax emphasis and another group’s convention in NYC has a speaker addressing the “Tax Implications to Seniors” from reverse mortgages. I look forward to the additional voices this brings to bear on what may be the next significant concern for our industry in increasing our market base.

The article was intended to provide information on how even the IRS has recently managed to “muddy” the advice it specifically gives to seniors on tax matters related to reverse mortgages. To demonstrate the problem, one illustration was chosen. That illustration only deals with when deductible interest related to a reverse mortgage can be deducted and absolutely nothing else.

Nothing in the article is intended to address or addresses any prepayment of interest. The interest that is due on a reverse mortgage can be paid at any time after it accrues, unless the note specifically restricts partial payments; certain proprietary products have temporary restrictions on partial payoffs (i.e. payments). There are no HECM products that have such restrictions unless some of the fixed rate HECM lenders have recently instituted them. If you are aware of any HECM lenders with partial payoff restrictions (other than interest adjustments), please advise.

There is a huge misunderstanding regarding Form 1098. It stems from a change in the reporting of interest since 1987. Currently that form is required to be sent by specified lenders to borrowers for whom the lender claims to have received over $600 in mortgage interest during the calendar year. In Box 1, that form declares how much interest the lender claims it has received, not how much the borrower can deduct. The same is true of Boxes 2and 4. The deductible amount is determined under Internal Revenue Code Section 163, the related regulations, rulings, notices, and other IRS documents as tempered by the courts.

Since the advent of Internal Revenue Code 163(h) with its segregation of home mortgage interest into Acquisition, Home Equity Indebtedness, and Personal interest categories, if taxpayers have known about these requirements (the product of Congress, not the IRS), they are generally mystified. Sad to say, many IRS auditors are no different. Most taxpayers mistakenly believe that what is shown in Box 1 of Form 1098 is the proper amount of their deduction. In some cases it may be but the IRS in Publication 554 is correct that many reverse mortgage borrowers will find much of the interest that the lender received may be limited if not nondeductible. More on that later….