How Can Reverse Mortgage Proceeds Be Income?

March 11th, 2009 | by Jim Veale Published in Commentary, News, Reverse Mortgage | 15 Comments

On February 27, 2009, RMD published Are Reverse Mortgage Proceeds Really Income? In that article the point was made that reverse mortgage payouts result in the increase of the amount due a creditor (a liability) and is not income which increases the borrower’s equity. In accounting literature, income is a temporary category of equity.

On both March 4^th and 5^th, while “Googling” “reverse mortgage daily”, the following ad came up in the first position on the right side of the Google results webpage:

The last line of the ad, which is a URL of the lender, was intentionally left off. The downloaded free guide only discusses reverse mortgages. All that can be concluded from that guide and the ad above is that this lender is declaring that reverse mortgages “earn tax-free income.”

Let’s be clear; if it is all right to call proceeds “income” then certainly it is appropriate to describe the growth in a HECM as “earned” and since in most cases, it is expected that the anticipated proceeds from the sale of the home net of selling expenses will exceed the amount of the reverse mortgage due at time of repayment, it may be “reasonable” to describe proceeds as “tax-free.”

In many business activities, income is earned by foregoing certain activities. For example, those holding a non-competition agreement will “earn” income by not pursuing certain business activities. Farmers “earn” government subsidies (taxable income, not loans) by not growing certain crops. So if RM proceeds are income, then to say that borrowers will earn tax-free income from not using those proceeds is clearly a logical conclusion since the amount of the available proceeds grows over the time that proceeds are not used by the borrower. This growth is also reflected in tenure payments and other periodic payouts.

Over the last few years, positive steps have been taken by many of the major marketers to move away from describing loan proceeds as “income” using terms like “cash,” “increased cash flow,” “supplement to monthly income,” and other appropriate descriptions instead. However, at the same time, there have been those who have taken the lead to create misleading ads like the foregoing.

Like the last installment, this segment also contends that it is not right to call loan proceeds “income.” In fact using that word to describe RM proceeds is not only misleading but also deceitful. Despite the actions of some, it is not smart, cute, or cleaver to call proceeds income.

When one looks at what increases the balance that a borrower owes, there is no question that accrued expenses such as servicing fees, interest, and MIP do. So do proceeds. So if loan proceeds are actually income, then both income and expenses increase debt. How is that even possible? It is utter nonsense. Proceeds are not income.

Does anyone actually believe that if a RM lender was somehow shorted on a proprietary loan (where the borrower obtained and held those “shorted” funds) that the RM lender would appear in court arguing that RM proceeds are “income” to the borrower? This article asks those leaders and originators who advocate the use of the word “income” (to describe RM proceeds) to speak up and say why it is right to do so.

The foregoing ad is wrong. When a HECM credit line grows based on the unused balance, it is an increase in the proceeds available to the borrower. The amount is not earned; it is simply a guaranteed growth factor making additional proceeds available to the borrower and is built into the terms of a HECM.

Let’s not kid ourselves. If some of our most respected leaders are intentionally endorsing the use of misleading terms (as described in the prior article), then is it really so surprising that many originators get things unintentionally wrong by carrying the actual meaning of such terms to their logical conclusions? If this is the situation in the industry then it is correct to state we market to seniors but not that we educate them. However, the vast majority of our leaders and originators are very responsible and do their best to educate; these individuals make our industry better. Let’s stop confusing seniors and ourselves; proceeds are not income.

Reader comments to the first installment of this article were excellent. Mr. Abel Torres cited a superb reference, Social Security Ruling (SSR) 92-8p which, as Mr. Torres pointed out, states in part: “A loan means an advance from lender to borrower that the borrower must repay, with or without interest” and “any advance an SSI applicant or recipient receives that meets the above definition of a loan is not income for SSI purposes since it is subject to repayment.” The reasoning in the ruling is absolutely biased; however, in this case the Social Security Administration (SSA) is looking to find income, not exclude it. It is, therefore, quite significant that SSA did not find any element of income in a bona fide loan.

Mr. W L Pulsipher informed us that his firm does not use the word “income” to describe proceeds. They call them “cash.” Others added similar insight and comments.

As Mr. Torres pleads, there are many other examples of governmental and other significant institutions concluding that loan proceeds are not income. For example, many cities base their business license fees on the income of the business. Are there any that describe loan proceeds as income for this purpose? Many of these cities desperately need revenues so if there was any way possible to justify loan proceeds as income, they would already be doing it. California is almost bankrupt but its income taxing authority, the California Franchise Tax Board (considered by many in the tax field to be the most aggressive state taxing authority in the US) has never taken the position that proceeds from bona fide debt are income. Accounting principles require entities to record loan proceeds they receive as liabilities, not income. In lawsuits attempting to collect loan proceeds, has any plaintiff (lender) ever called them “income to the borrower”? So why do those in our industry call proceeds “income”? Readers are encouraged to add other examples.

On March 20^th, the final installment of this article will be short. It will be a call to all readers to cite evidence as to why it is acceptable to call loan proceeds “income.” I hope that there will be an overwhelming wealth of evidence backing up the contention that RM proceeds are income. This author has reached wrong conclusions before and it is not hard to believe it has happened again.

James E. Veale, CPA, MBT
SVP of Tax and Government Affairs & Director of Originator Recruiting for Security One Lending

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http://www.firstloans.net Mike Gruley

I cannot agree with any argument that calls proceeds from a reverse mortgage “income.” From a tax standpoint, income is cash, equity or value that is over and above what an individual currently has possession of.

In the case of a reverse mortagage, the conversion of illiquid equity to liquid equity is only, in my view, a balance sheet tranacation. An over simplified example might be if you liquidated your bank CD and transferred it to your checking account. Other than the small amount of interest the CD earned, there is no income. If you owned a watch that you bought for $100 and then sold it for $100, there would be no asset gain, just a conversion from one asset type to another.

Calling money received from a reverse mortgage “income” is not only incorrect in my view, it is terribly misleading to the consumer who is fearful of taxation, and in my way of thinking has no value in an advertisement. “Tax free income implies that the borrower is gaining an asset or improving their wealth without haveing to pay Uncle Sam. That is just false.
http://www.seniorzone.net Jim

Since the profit made on the sale of a home is tax exempt by I think $250,000 per owner, meaning $500,000 per couple, then the proceeds from a reverse mortgage that are under that amount should also be exempt, correct?
http://www.remalo.org Sam Collins

I agree with Mike and Jim, reverse mortgages should not be classified as income. The reverse mortgage business continues to evolve. Often references to “income” are not meant to be malicious. However, moving forward consideration should be to review all your marketing materials to remove references to income.
Thanks to Jim Veale who has helped me further understand the nuances of this business.
James A. Nelson

I’m amazed an Industry (HECM) that has been in business for over 20 years is still having this discussion. Common sense tells me HECM Funds are the result of a loan which has to be repaid. If one had to return his payroll to his employer at year’s end (Just a temporary loan you see , a silly thought I know), would you call those funds income? It appears to me the Company HECM Department V.P. or Manager didn’t provide proper oversight of his Advertising Manger (or Agency) or failed to provide correct information to the creative ad department. However, I
am surprised this issue isn’t “cut and dried” with a specific IRS Ruling–and maybe there is: It’s just
one is hesitant to ask the IRS. I really don’t like telling Seniors emphatically that HECM Funds are NOT
income and be wrong. I’m going to e-mail the Director of the IRS and let me see if his people will site me
a ruling.
Robert Fierro

mmmm….What’s in a word. Admittedly, I got carried away and sloppily used the word “Income” in one of my trifolds. I’ve found that in most cases, many folks do not have the insight into the details of accounting that most emphatically make the proceeds of a revese mortgage non-income, but instead think of any positive cashflow, even if temporary, as “income”. After all, if its coming into my house, it must be “income”.
Then again its such sloppy thinking and lack of understanding that has lead many people and our government “down the garden path” to financial disaster.
KUDOS to Mr. Veale for reminding us that we, in the Reverse Mortgage market, are tasked to serve the best interests of our clients in every possible detail.
Calling the proceeds of a Reverse “income” is disingenuous, at best.
OK… I guess it’s time to crank up Microsoft “Publisher” again and do some editing.
Abel Torres(eqqmc2)

Thank you Mr. Veale for bringing this issue to the forefront and once more clarifying that reverse mortgage proceeds are not considered income and therefore the term income should not be used at all in any reverse mortgage marketing material when describing loan proceeds.

To James Nelson: Indeed we do have an old IRS ruling that sorts of indirectly addresses the issue, although it was meant to adress when is the interest repaid on loan deducted. It would better to have, like you say a “cut and dry” IRS ruling on this issue.

To illustrate this point with further evidence, I would recomend the following book (texbook) for those of us who are not accountants by trade:
“Accounting for Non-Accountants” by Graham Mott, 6th ED, http://www.kogan-page.co.uk.
In page 31 the following paragraph the author cites:
“A loan is a cash receipt, but it cannot be counted as income in the profit and loss account as it must be repaid at some future time. It is therefore shown as a liability in the balance sheet. When the loan is eventually repaid, such repayment is not an expense in the profit and loss account, but a reduction of the asset cash in the balance sheet.”

This was really explained in the original article by Mr. Veale in more technical terms (ie the basic accounting equation, from Financial Accounting theory) . So bottom line from Government Agencies to Accounting Theory books we can safely conclude that Reverse Mortgage Proceeds are NOT to be called income.

Thanks to all the readers for their comments and Mr. Veale for the great contribution to our industry.

Abel Torres
James A. Nelson

The internet is amazing. First, by calling the IRS Consumer information number I learned to contact the Director one must write. Second, a very, very, very helpful IRS Employee (after four transfers) sent me to the IRS website (www.irs.gov); then, in the search box
click on pub 554 (Publication for Seniors) and go to page 18–scroll down to REVERSE MORTGAGES and read what is the IRS official position on HECM proceeds. I’m going to carry that page with me to Client meetings at all times now.
James E, Veale, CPA, MBT

The purpose of the articles has not been to discuss tax matters. That is a separate topic.

However, I know of no HECMs, HomeKeepers, or proprietary reverse mortgages that a tax examiner would find as anything other than bona fide loans/debts. Proceeds from a bona fide loan will never be taxable if the loan is repaid in full by either the borrower or from the proceeds from the loan are sufficient to pay off the related debt except in certain rarely occurring events:

1. If a lender forgives or cancels debt, normally a recognizable taxable event will result.

a. This usually occurs in foreclosure or through a trustee’s sale.

b. Since a reverse mortgage is nonrecourse debt, the amount cancelled will usually increase the amount of gain or reduce the amount of loss (sometimes resulting in a net gain).

i. The gain will generally be excludible under the $250,000 or $500,000 exclusion of gain on the sale of a principal residence.

ii. In some cases, no exclusion may be available.

2. In the rare case of fraud, a guilty party could incur income tax liability.

A very, very technical argument can be raised about proceeds received when the value of the home is less than the amount of debt due after receipt of those proceeds. In conversations with the IRS personnel I worked with to change the reverse mortgage section of Publication 554, they do not consider that event a taxable event. However, even though it is counterintuitive, this taxable event could have a neutral or even positive impact on the borrower. In this particular case the result is generally excludible under Internal Revenue Code Section 108 and because of certain basis adjustment rules, the result could work to the taxpayer’s favor but this is way beyond the topic at hand.

As to whether loan proceeds of a bona fide RM should be called “income”, the IRS “has no dog in this fight.”
—————————————-

This comment has been written to make readers aware of taxable issues related to certain loan transactions. Because tax transactions are not only dependent on law but also the facts and circumstances of the taxpayer, the IRS requires that readers be notified that the foregoing comment cannot be relied upon to mitigate or otherwise reduce any tax penalties. Readers should seek the advice of a knowledgeable, experienced, and competent tax professional who is aware of his/her individual facts and circumstances in determining the tax effect of such matters.
Todd

I have been reading about this discussion all along and cannot believe the intensity of this discussion. We all should know AND EXPLAIN TO THE BORROWER the IRS has determined the funds you receive from a RM are not considered income. They are considered a loan payment and therefore are not taxable.

To a homeowner, however, it is going to be considered income. They only have two items on their table; income and expenses. The words income and expenses are merely terms they use to describe what they have. Such as, “I have all these bills and don’t have the money to pay them!” or “I have all these expenses and don’t have the income to pay them.” The word ‘income’ cannot be used as an absolute term to mean only one thing. When we use expressions like “increasing your monthly spendable income” the expression is used to relate to the homeowner. Have you ever read your homeowners policy? Aren’t you glad your insurance agent explained it to you in terms you could understand. We can all agree the RM (or should we “ALWAYS” be calling it the Home Equity Conversion Mortgage) is a program that requires a lot of education to the homeowner. In order for the homeowner to have the best grasp of what the program has to offer, the LO has to talk in terms they can understand.

This discussion started out talking about the deceptive advertising where seniors are duped into believing the solicitation is from the government. I agree THAT is wrong. I believe all solicitations should clearly inform the recipient the advertisement is not affiliated with any government agency It should also avoid any misleading artwork or logos.

The final point I want to make in regards to the word ‘income’ and it’s inability to be used as an absolute lies in Medicaid. SRS does not consider the funds received from a RM income in the month it is received but does consider it in the second month. For instance: If a borrower recieves $30,000 in the month of April and still has $25,000 of the $30,000 left in the month of May, the $25,000 is considered income or available assets in regards to medicaid eligibilty. Now what are the tax consequences? No one has entered into this discussion yet. Nor would I presume does anyone really want to.

Therefore, the word income will have several meanings or definitions. Just like the words ‘work’ and ‘plane’.

For example:
I left ‘work’ to catch a ‘plane’ only to find my keys did not ‘work’ to lock the door because of the latch. I planed down the door with a wood ‘plane’ in order for the key to ‘work’ and I was finally able to leave ‘work’. I caught the ‘plane’ and spent the weekend flying over the ‘Plane’ (a river in eastern Germany).

Sorry, I was always taught to explain things as though I was talking to a fifth grader!

My point being; if we have to clarify the interpretation of every word or phrase in our advertising, our mailers will be as thick as the RM closing documents themselves. Let’s keep our focus on eliminating the deceptive practices of using government logos, formats and artwork. That is an area we can ALL agree should stop!
James A. Nelson

Mr. Veale: What you have just written would baffle or scare a piss-ant, let alone a Senior. I think I’ll just stick with page 18, IRS Publication 554 2008.
If you had a hand in writing that section in ordindary laymens’s English, I commend you Sir. CPAS and Lawyers
function and write in different worlds than we common folk. Your intellectual capacity is absolutely
outstanding. You, Sir, are a tribute to your Profession and RMD is most fortunate to enjoy your
thoughts.
James E, Veale, CPA, MBT

Correction to my own comment. the second paragraph should have read as follows:

I know of no HECMs, HomeKeepers, or proprietary reverse mortgages that a good tax examiner would find as anything other than bona fide loans/debts. Proceeds from a bona fide mortgage (loan) will never be taxable if the amount due is paid in full by either direct payment from the borrower or indirect payment through the proceeds retained by the lender as a result of the sale of the home; however, proceeds may be taxable in certain rarely occurring events:
Amy Marshall

Someone may want to contact North Carolina about this. The very first line of their Housing Finance Agency about reverse mortgages calls it income.

http://www.nchfa.com/Homebuyers/HOreversemortgage.aspx

Other sites calling it income are:

http://www.lifeandhealthinsurancenews.com/Exclusives/2009/02/Pages/Reverse-mortgages-for-income-The-jury-is-still-split.aspx

http://www.myvalleylender.com/

and there’s even a place that calls themselves Seniors Equity Income at http://www.seniorsequityincome.com/FAQ.html

Its a cut and dry case to me but I’m forever grateful for Mr. Veale’s substantial explanation.
James E, Veale, CPA, MBT

Todd,

In November in Phoenix, I spoke to a gathering of over 150 current RM borrowers, 30 potential borrowers, and a few professionals who were there to find out about RMs. A friend of mine holds such events at least twice a year for those he has helped over the years.

Several of those seniors talked about their savings, their cash on hand, and other facets of their personal “balance sheets.” Some were even concerned about their financial legacy to their children.

Yes, I meet seniors, particularly older seniors who speak in the terms you describe. Normally I discuss having more money available to them to pay their bills. Guess what — not one of them has ever misunderstood what I meant the first time I said it.

Our education is not to correct what words seniors may use in everyday speech. It is to educate seniors using words they can comprehend that are clear, meaningful, truthful, and accurate.

Your statements are not only oversimplifications; they insult most seniors I know. To ascribe your idea of the mental capacity of seniors is not just demeaning but shows a lack of consideration and respect for those who are 62 years and older. Mr. Nelson certainly knows the difference between money coming from a HECM and receiving cash from income. Mr. Nelson has told us all he is over 61.

My own father is 90 years old. Sir, he plainly understands the difference between money from income and money from debt. So do many others I have met over the age of 90.

Proceeds are cash received and its source is not income even for Medicaid purposes. The reason HECM proceeds are of great concern in a Medicaid setting is the asset (not income) test that must be passed at the end of each month to determine the level of eligible benefits available to the Medicaid recipient. If excess non-excludible assets (particularly cash) are on hand, the result can even develop into repayment issues.

I realize income tax issues can turn into Medicaid issues but unless fraud is involved, please explain how and why Medicaid issues can turn into income tax issues.

What I do know is that most of the time interested seniors turn down a HECM is because of costs. But the second most common reason I have found is because the potential borrower finds out HECM proceeds are not income but are loan proceeds that increase a debt.

Todd, I find your comments nothing more than an excuse to continue your form of marketing. You are free to advertise any way you want but don’t excuse it by making ALL senior homeowners look like they cannot understand what additional money from a HECM will do for them unless it is call “income”.
mrreverse

I question Jim Veale who was supposed to get back to me. When we did 125% forward mortgages the amount you recived over 100% of the value of the home was considered profit and was taxed. using that logic if you have a home worth 300,000 and you take out in a lump sum 375.000 because credit line grew to that amount could this be considered profit and then be taxed?

other question was on a home equity loan you can only deduct interest up to 100,000. what about intrest on a 625,250. loan.or any loan over 100.000?
James E. Veale, CPA, MBT

mrreverse,

The reason for the delay is that I have not spoken with the IRS National Office since our last conversation. On the forward mortgage side, where were the mortgages being placed (state mortgage/real estate law issues affect income tax rules)? Was the debt considered recourse or non-recourse? If I am not mistaken your company was issuing Forms 1099-C (current form) when the loan was funded.

Rather than attempting to answer a tax question again in this article, I will defer any such answers until the articles begin addressing income tax matters which should be shortly. However, as to economic and accounting income, proceeds may result in gain; however the time of determination is when the lender forgives/cancels any portion of the debt and/or the debt is paid in full. If the amount cancelled is less than the amount of any accrued but unpaid interest at the time of measurement, arguably it seems no gain results from the proceeds but rather the accrued interest. Gains from proceeds only seem to result to the extent that the amount of the debt cancelled exceeds the accrued interest. All of this gets very esoterical, subject to argument, and hardly worth the effort, time, or space.

How Can Reverse Mortgage Proceeds Be Income?

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