Tax Consequences Resulting from Foreclosure on a Reverse Mortgage (Part 2)

June 23rd, 2009 | by Jim Veale Published in Commentary, News, Reverse Mortgage | 67 Comments

The RMD article Tax Consequences Resulting from Foreclosure on a Reverse Mortgage, pointed out that there are income tax consequences to borrowers from reverse mortgage (and other nonrecourse) debt that is forgiven in foreclosure, short sales, trustee’s sales, and deeds in lieu of foreclosure (all referred to in this article as “foreclosure”); these tax rules are much different than the rules for debt forgiveness in other situations. This article covers the same rules but as to successors in interest who receive their interests in the home as a result of the death of the borrower.

Back in 2005, a statement similar to the following was found at the correspondent’s portal on the website of a lender: “Reverse mortgage proceeds are tax-free income because they are not income and, therefore, because they are not income, they are tax-free.” The statement is not only circular but is also wrong. Just because nonrecourse debt proceeds are not income when received under income tax law does not mean they will not become taxable if they are not repaid.

IRS Compliance and Explanations

When debt is forgiven (outside of abandonment), lenders must complete and send out Internal Revenue Service (IRS) Form 1099-C. The IRS has released 2009 Form 1099-C which changes Box 5 on the 2008 Form 1099-C to Box 4 and in new Box 5 lenders (and service providers) are asked to declare if the borrower was or was not personally liable for repayment of the debt. The issuer should provide the information on the form needed to determine the adjusted sales price and the amount of accrued interest included in the reverse mortgage debt forgiven. Reverse mortgage borrowers should determine from the service provider if the amount shown in Box 2 as accrued interest in the debt forgiven, is duplicated in Box 1 of Form 1098 showing the interest received by the lender during the calendar year.

For more information, please see the Instructions to 2009 Form 1099-C, IRS 2008 Publications 4681 (“Cancelled Debts, Foreclosures, and Repossessions, and Abandonments”) and 523 (“Selling Your Home”). Publication 4681 has a great deal of information on both recourse and nonrecourse and good illustrations on recourse but not nonrecourse. Unfortunately one has to be careful in reading the Publication since at times it is not obvious if the rules being discussed apply to recourse or nonrecourse debts, such as the discussion on Page 4 that covers the recourse deductible debt rule under the 1986 Internal Revenue Code as Amended (IRC) Section (§) 108(e)(2).

Heirs, Trusts, and Estates

Many individuals mistakenly believe that those succeeding to a home securing a reverse mortgage as the result of the death of the borrower where the debt exceeds the value of the home will not have any income tax consequences due to foreclosure. For decedents passing away prior to 2010 or after 2010, generally gain will arise. The reason is that the successor has a fresh start basis in the home equal to the fair value of the home as of the date of the death of the decedent. Thus if the balance due is greater than that value and foreclosure occurs, the balance due will be treated as the adjusted sales price and the value as of date of death of the borrower as the tax basis resulting in a tax gain to the estate, trust, or heirs.

2010 is a messy tax year unless Congress eliminates the laws that are written to go into effect at the beginning of 2010 and then terminate at the end of 2010. President Bush got legislation passed that tinkered with portions of the IRC for one year and then “sunset” with the hopes that if they proved to stimulate the economy, Congress would permanently incorporate them into the IRC. President Obama has expressed the intent to eliminate some of these one year provisions.

The estate tax is one of the provisions. It is scheduled to terminate for one year going back into full force on January 1, 2011. If that event occurs, there will be no fresh start basis on property transferred as a result of deaths occurring in 2010; successors will inherit the tax basis of the decedent in the assets inherited. With no help from the decedent passing away in 2010, determining basis could become a stressful and overwhelming experience for many successors.

As to exclusion of gain on the sale of a principal residence, IRC § 121 is generally not available to successor owners unless they qualify on their own. IRC § 121(d)(11) is a one-year provision that allows successor owners of a home that served as the principal residence of a decedent (from whom the successor acquired ownership as a result of the death of the decedent) to include the use of the home by the decedent with their own use in determining IRC § 121 eligibility. Obtaining any benefit from this provision will be difficult since the decedent must have died in 2010 and the sale completed before 2011. Verifiable determinations of the use by the decedent may prove difficult without the help of the decedent.

Some or all of the reverse mortgage accrued but unpaid interest as of the date of the death of the decedent may be eligible for deduction when paid under IRC § 691(b), commonly referred to as “deductions in respect of a decedent.” The rules are complicated and the deduction is generally limited to the amount that would have been deductible had the decedent been alive at the time that the interest was paid. Depending on the facts and circumstances of the successor, interest accruing after death may be deductible under IRC § 163 but generally not under IRC § 163(h)(3) unless the successor is using the home as a principal residence.

Some Planning Pointers

Intended successors should be included in tax planning sessions. “Paying down” or refinancing a reverse mortgage may be economically beneficial for borrowers in specific tax situations if a substantial portion of the interest that is treated by the lender as paid can be deducted. However, in other situations, the successors can use the deductions on a more beneficial basis (following the death of the borrower) than the borrowers can in their life time. In any case, as early as possible, borrowers should gather information successors will need in event of death.

A good planning technique is having a revocable trust own the home that is security for a reverse mortgage as long as that is the only asset held by that particular trust. This way if the income tax liability from foreclosure is larger than the tax benefits, trust beneficiaries can disclaim their interests in the trust and the income tax liability will generally not have to be paid.

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

The foregoing is intended to introduce some of the tax aspects related to the foreclosure of a reverse mortgage. Tax implications can be complex. The IRS requires that readers be advised that this article cannot be relied upon to mitigate tax penalties. Accordingly, readers are encouraged to have homeowners who either have a reverse mortgage or are seeking to obtain one seek the advice of tax professionals who are competent, knowledgeable, and experienced on the income, gift, and estate tax implications of reverse mortgages to both borrowers and their heirs.

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Anonymous

James,rnrnTwo people who had a bank paying them on a reverse mortgage have died, that property is going to sale thru the public trustee and I want the property and have been looking very hard at the neighborhood. brief info, property purchased by bank in 06 for 392k, remaining balance of the reverse is roughly $255k, property is probably worth 392k or more, there is a law office for the bank involved, shouldn’t the bank continue payments to heirs? would the bank want the money they’ve paid out back, the money they haven’t paid out, both or fair market value and legal fees? I’ll watch for posts and I will try to find a contact number for you…. Also, given the tax consequences, I could try to find the decedants ex-POA who was on the account prior to death and with the same name could be the heir to receive the tax bill if there is one… confusing and I’ve been in Financial Services for 18 years…. sTEVE
Anonymous

The decedent had taken out a reverse mortgage on her home. The bank is now trying to sell the home, but in this economy the bank may not recoup the mortgage amount. If the bank issues a 1099C, is this taxable income to the estate. Cancellation of debt is not taxable on qualified personal residences due to the The Mortgage Debt Relief Act of 2007. The heirs have not and do not plan on taking ownership of the home. rnThe estate attorney is concerned that the estate will owe taxes if a 10999C is issued. I can’t seem to find anyone who knows the answer. Any thoughts?
Anonymous

Another point is that in buying the house, the contract notes that I will be responsible for paying off the reverse mortgage lender.rnTaylor DDS
Anonymous

Thank you for your reply, sir. I will pass it on to my accountant. Interestingly both he and the estate’s accountant feel it should be deductible by me. However I haven’t been totally confidant in this and to be honest, everyone else I’ve contacted has been very vague, and I’ve checked with some (I think…) top tax people in my area. Can you suggest someone in the Dallas/Fort Worth area? ThanksTaylor
Anonymous

While this is an interesting question, it is also a question inviting malpractice. I will provide some general guidance but your question did not provide specific enough information to begin to address the many layered issues it brings up. rnrnYou need the help of an income tax advisor who is familiar with estate income tax and real estate laws within the state where the property is located and also estate law and estate income tax law where the estate is domiciled if it is different. Such advisor should be: 1) competent, 2) knowledgeable regarding the specific type of reverse mortgage involved, estate income tax law, and interest deduction rules applied to both the period that the estate owned the home and then separately as to the decedent and that personu2019s ownership of the property, and 3) experienced in such matters.rnrnWhat is clear is that Internal Revenue Code Section 691(b) controls the allocation of the deductible portion of accrued but unpaid interest due as of the date of the death of a decedent. To the extent that the estate receives the deduction, it must deduct it. In the year of termination, excess deductions are allocated to heirs. rnrnNo part of the interest deduction accruing before the sale goes to the purchaser of the home based solely on the purchase. Such interest goes to the estate, if the estate held title due to the passing of the decedent. Of course if the home was specifically devised in a will to the subsequent title holder and such devise was required to be immediate, that will generally have a different result as to the devisee depending on state law. Then there is also the question of disclaimer but that exceeds any answer that should be provided in this setting.rnrnThere are many types of reverse mortgages. I know of no reverse mortgage that is a recourse debt. If it is not due and payable, the purchaser takes title in the property u201csubject to theu201d reverse mortgage. The only way that could be true, however, is if at least one original borrower is alive, still holds an interest in title in the home, and lives in the home as the principal residence of that person. rnrnIn an acquisition, accrued interest that accrued before acquisition is never deductible by the acquirer, only by the seller. It is only the person who legally had the obligation to repay it or if more than one obligor, as agreed and permitted by the tax law.rnrnInternal Revenue Code 691(b) allows deduction of interest to the extent that the decedent could have deducted it if the amount had been paid in full immediately before death. If the deduction is a result of u201cexcess deductions on terminationu201d from an estate, the deduction can only be taken as an u201cother deductionu201d on Form 1040 Schedule A subject to the 2% floor and is not deductible for alternative income tax purposes. rnrnIf the deduction is paid in a year other than termination and the property was owned by the estate at any time following the death of the decedent, then only the estate can deduct the interest and if it could only have been deductible as home mortgage interest by the decedent and the total deductions (such as the home mortgage interest) exceed net income from all sources, the excess is generally lost; it cannot be carried forward or carried back.rnrnOf course different rules could apply to a principal residence whose title was held by a revocable trust. rnrnAgain it is highly recommended to seek the help of a professional tax advisor as described above. This answer was not intended to provide specific advice and therefore, cannot be relied upon to mitigate any penalties that the IRS might assess.
Anonymous

If an heir buys the house with the reverse mortgage and assumes the debt in agreement with the other heir(s) can the heir-buyer deduct the reverse mortgage interest on the deceased parent’s 1098 if the deduction is flowed to that heir with a K-1 from the parent’s estate tax return?
Anonymous

dduck12,rnrnThis is why whether you are right or not or some type of exemption applies in NYC, it is important for those are considering getting a reverse mortgage to seek the advise of a tax advisor who is competent, knowledgeable, and experienced in such matters in the locality where the property is located. This also applies to those who are considering restructuring ownership so as to minimize any income or estate tax liability. In some localities, a change in title can result in a property tax reassessment. In California as long as the owners of the property are the trust beneficiaries, exemptions generally apply.rnrnWhile life insurance or a sinking may be a good alternative, insurable caps and other factors could come into play along with exposure of the life insurance proceeds to inclusion in a taxable estate increasing an estate tax liability, if any.rnrnI am glad you brought this up. Getting competent advice on such matters is very important.rnrn
Anonymous

Some additional information regarding using a revocable trust, pertinent at least in NYC and NY State but hopefully not in other jurisdictions. (One should check local laws on this.) There may be an out of pocket cost, in addition to the drafting cost of the trust; it could be substantial. It is a transfer tax quoted from this web site:rnrnhttp://www.docstoc.com/docs/3274615/New-York-City-Real-Property-Transfer-Tax-NEW-YORK-CITYrnrnNew York City Real Property Transfer TaxrnNEW YORK CITY REAL PROPERTY TRANSFER TAX Regulations on Continuing Lien Exclusion From Consideration Regulations on the Change of Identity or Form of Ownership or Organization Exemption and Transfers of Controlling Economic Interests Form NYC RPT and Instructions1% If Consideration Is Less Than $500,0001.425% If Consideration Is Greater than $500,000 For The Following Transfers:Conveyances where the real property transferred or the real property in which the economic interest transferred is a one, two or three family house, an individual cooperative apartment, an individual residential condominium unit or an individual dwelling unit in a dwelling which is to be occupied as the residence or home of four or more families living independently of each other,and Grants, assignments or surrenders of leasehold interests in a one, two or three family house, or an independent dwelling unit in a dwelling which is to be occupied or is occupied as the residence or home of four or more families living independently of each other.Other Transfers:1.425% If Consideration is $500,000 Or Less$2.625% If Consideration Is Greater Than $500,000(Special Rate For Transfers to REITS)Note: New York State Tax Law, Section 1201(b) and Section 11-2102 of the Administrative Code of the City of New York have been amended effective August 28, 1997 to allow for the City’s Real Property Transfer Tax a continuing lien deduction from consideration on the transfer of a one, two or three family house, an individual residential cooperative or condominium unit, or an economic interest in such property if the lien continuing existed before the date of transfer. The deduction will not be allowed on a transfer to a mortgagee, lienor or encumnbrancer or to a REIT. A Bulletin of the New York City’s Department of Finance on the application of this deduction is anticipated.Tax must be paid within 30 days of the date of transfer or interest and penalties will be assessed. Tax is payable by the Transferor but there is Transferee liability.rnrnSo, if I am correct, transferring a $500,000 property would cost $5,000 in taxes to NYC and I believe another $4 per thousand to NY State, or $2,000; total $7,000. I hope I am wrong and this does not apply to a Revocable Trust.rnAn alternative, if available and practical, would be either life insurance or a sinking fund to pay for the potential tax liability of a short sale.
Anonymous

You have to watch these east coast governors carefully.rnrngood weekend to all.
Anonymous

dduck12,rnrnHOA stands for Homeowners’ Association. This shows I have less knowledge about NYC coops than I thought. Where the former governor went.rnrnHave a great weekend.
Anonymous

Mr. VealernrnI was forced to become a 12 by the the new forum system. Like the government, the internet is all powerful. rnI see that some careful coordination among a will (hopefully, most people have one) a single asset trust (and a possible other trust) is needed. rnMy main concern now is for the advent of co-ops being eligible for HECMs and the inevitable skepticism of co-op boards. I personally ran a trial balloon in my building and the main financial guy, a CPA who also specializes in financial planning did not do back flips in anticipation of RMs for co-ops. I also went to a CE meeting this week and one subject was retirement planning and sources of income. I added that in some cases an RM could be very useful. As it happens, one of the other attendees was involved with the Council of New York Cooperatives and Condominiums, and they are discussing RMs. He also expressed concern that there were scammers out there pushing proprietary RMs and that fees for RMs in general were high. Clearly, RM originators will have to continue to educate and these people. But the point is, it would be nice to be able assure boards that there is some mechanism to pay the maintenance charges, otherwise they may not approve applications for RMs. I assume you have heard that some condos in Fla. have to chase banks for the condo fees on foreclosed units.rnBTW: I don’t know what a HOA is (it’s not what former Gov. Spitzer went to, is it?).rnI consider myself to be a concerned retiree and a member of the financial planning industry (we used to be insurance salesmen, when I frst started), and believe RMs are a useful planning tool and I am trying to educate people in my little universe. I have no official affiliation to the RM industry, just a fly on the wall.rnHowever, I would like to see more RM originator cross-pollination with CLUs, ChFCs, CFPs and financial planning CPAs. Perhaps Snoopy is working on that phase.rn
Anonymous

dduck12 (I am assuming you are AKA dduck),rnrnI appreciate and value your compliment.rnrnWe all hope you are right about short sales and even foreclosures. Like you I believe the horizon on home values is bright but when we get there is still uncertain.rnrnUnless it can be assured that there will be no other assets in the estate, it is hard to beat the single asset trust when it comes to reverse mortgages.rnrnTo the extent that payments are made directly to vendors, directives in a will or the governing document of another trust could handle those issues. To the extent payments must be made to or through a concerned HOA, why not set up some type of escrow account with 12 months of payments deposited into it? Any earnings would be paid to the borrower and the HOA would be paid until the property (or stock) is sold and could even be adjusted annually. Or the single asset trust could be expanded to add the cash needed to care for the situation since the income tax liability will not be reflected on a tax return for some time following the death of the borrower; of course, any cash not used for trust expenses will be subject to the claims of the IRS. If that does not satisfy the situation, the use of the single asset trust may not be practical. rnrnMost seniors in Southern California do not face HOA issues the way that seniors owning coops surrounding Central Park in NYC do. Some advisor dealing with HOA situations will probably provide a more satisfactory and practical answer.rnrnBy the way there is much specualtion among RMD readers about your involvement in the RM industry. By now if you are not already involved, you should be.
Anonymous

Mr. VealernrnOnce again I thank you for providing this forum with invaluable information.rnAs we all know, sometimes the devil is in the details. The trust route sounds right for cautious types like me. Chances are from this point, at least I hope so, given average borrower longevity, most properties will not be short sales. However, a revocable trust allows for much easier and less costly changes (like the beneficiary of a life insurance policy) than a writing a new will to change the successor designation.rnFor those that wish to honor their obligations, one point bothers me. If the trust has no money for the tax people, it also does not have any to continue property taxes, insurance, condominium or co-op (hopefully, soon) costs. Who pays and how? As far as a condo or coop, I think the boards would be concerned about this. It could take a while for a sale to take place, or does the bank sell very quickly in real life because of the FHA “insurance”? rn(BTW, I’m assuming that under an estate situation, the estate would/could pay these costs.)
Anonymous

Mr. B,rnrnThe circumstances causing the note to become due will not impact the tax result of selling a home for less than the amount due on a non-recourse debt. Such a sale is generally referred to as a short sale and is included in the word u201cforeclosureu201d as that word is used in each article. As long as the net sales proceeds are insufficient to pay off the balance due on a non-recourse debt, debt is cancelled resulting in additional taxable proceeds beyond the actual sales price.rnrnAgain if the borrower is alive, gain or loss results from the sale of the security based on the rules described in the first article. If the borrower has passed away at the time of sale, the rules described in the article above apply and normally result in gain.rn
Anonymous

Still have a question?rnWhen a reverse mortgage note becomes due because the senior is no longer living there or is deceased but the home is sold for market value. Would this avoid the tax situation on any debt forgiveness?
Anonymous

dduck12,rnrnYou are right. Heirs can also disclaim in other trusts or an estate; however, an income tax liability still results and the estate or trust must pay that liability from its other assets. However, the technique suggested in the article avoids the payment of that liability.rnrnFor example, a borrower places title of a home in a revocable trust in which there is no other asset. Following death, the trust beneficiaries determine that the balance due on the RM is greater than the homeu2019s value and that the tax detriments far outweigh the tax benefits. As a result all of the heirs disclaim. Now the trustee prepares the trust income tax return and determines an income tax liability is due. The trustee and the IRS look for other assets of that trust and determine that there never were any. Without other assets, the IRS cannot collect payment. Thus the income tax liability will be forgiven and is legally avoided.rnrnIf the same situation existed and there was a $100,000 certificate of deposit also owned by that same trust, the IRS would have the right to collect income tax liability related to the foreclosure from the $100,000 certificate of deposit or if the trustee had distributed all of the money, the IRS would collect it from the trustee or heirs, whatever is ultimately easiest for the IRS.rnrnI hope that explains why this technique is so effective.rnrnAs to a charity, it all depends on the type of entity involved. If it is in an estate, a charity could not accept an asset with a liability exceeding its value. The same would hold true with a typical living trust. A charitable remainder trust is generally much different; however, a lot more detail is needed to adequately address your question.rnrnAgain my answer does not constitute opinion upon which the reader can rely on to mitigate tax penalties. Readers are advised to seek the tax advice of a competent and knowledgeable tax consultant who is experienced in such matters.
Anonymous

Mr. Stengel,rnrnIt is very clear that you and I view FHA mortgage insurance and PMI very differently. Even though I believe that the tax results are the same. So what is PMI?rnrnPMI is defined by the Federal Reverse Bank of San Francisco (u201cFRBSF, http://www.frbsf.org/publications/consumer/pmi.html) as follows:rnrnu201cPMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home’s value. In other words, buyers with less than a 20 percent down payment are normally required to pay PMI.u201drnrnPMI stands for private mortgage insurance and is nothing more than that. According to 12 USC Section 4901 (13) — (http://uscode.house.gov/download/pls/12C49.txt) — also known as the Homeowners Protection Act of 1998, private mortgage insurance is defined as follows: u201cThe term u2018private mortgage insuranceu2019 means mortgage insurance other than mortgage insurance made available under the National Housing Act [12 U.S.C. 1701 et seq.], title 38, or title V of the Housing Act of 1949 [42 U.S.C. 1471 et seq.].u201drn rnClearly FHA coverage is not PMI. Even the Internal Revenue Code (u201cIRCu201d) under Section (u201cu00a7u201d) 162(h)(3)(E)(ii) treats PMI as a separate category of mortgage insurance from FHA mortgage insurance which is classified under 162(h)(3)(E)(i). As explained to me by legal counsel, PMI is an actual insurance policy with all the terms, etc. explained in the policy. FHA HECM insurance on the other hand is a body of law that provides guarantees to those who qualify and participate.rnrnWhy the FHA coverage? Because no mortgagee would ever provide a loan based on such permissive terms without it. When you try to find its closest significant competition you find they all dried up. Why? Because they could not be profit justified even with their less generous terms.rn rnA HECM is non-recourse and the line of credit adjusts upwards (and sometimes slightly downwards) based on the increase in the principal limit, the decrease in the unamortized servicing fee set aside, the balance due and if applicable, other payout terms, and possibly, other factors such as a repair set aside. Tenure payments (if all covenants continue to be abided by) continue until the loan matures. Even term payments reflect a projected growth in the principal limit. The loan stays in force for as long as the covenants are met and thus the borrower can freely live in the home throughout that period. For home values under the HECM lending limit, there never has been any other reverse mortgage product with such high principal limits to maximum claim amounts. It provides wonderful consumer benefits but there are upfront costs.rn rnThe reasons for the FHA coverage are economic to encourage mortgagees to offer them; they are not tax.rnJust because a loan is paid in full does not mean the borrower paid it off. The HECM loan is non-recourse but not because FHA insurance pays it off. It is because the note itself must be non-recourse for the mortgage to qualify as a HECM.rnrnOne is free to make your equity argument but it is not based on anything found in tax law. For those who are less acquainted with the taxation of insurance proceeds, your argument is persuasive. However, it is not correct. All insurance proceeds are subject to income tax unless specifically excluded by the IRC, such as life insurance to the extent provided by IRC u00a7 101 and most medical insurance by IRC u00a7 104. IRC u00a7 1033 dealing with involuntary conversions is a common source of taxation of insurance proceeds.rn rnThe payment of the amount unsatisfied from foreclosure under a non-recourse loan is not a benefit to the mortgagor — that amount is forgiven by the note itself; it is only a benefit to the mortgagee. Whether the mortgagee is paid by FHA or not, as to the mortgagor the loan is deemed paid in full in foreclosure, period — because the underlying note itself is non-recourse.rnrnI hope that answers your excellent questions.
Anonymous

Mr. Veale,rnrnSorry for being dense, but isn’t disclaiming under a will, where an heir is named as a successor to the property, the same as disclaiming under a trust?rnI suspect there might be other estate planning reasons for using the trust route.rnIt would be interesting to know if there are. Perhaps a lawyer using the trust route would care to comment.rnAlso, If the intended successor is a charity, am I correct that the tax issue is a mute point?
Anonymous

dduck12,rnrnI have heard of one law firm that was creating such trusts before I even began discussing them. In Los Angeles at the last NRMLA national convention, an attorney representing a title company recommended using such trusts for other issues.rnrnYes, heirs have disclaimed to avoid such tax; however, I know of no such case involving reverse mortgages. Again I do know attorneys who regularly use this technique.rnrnThere is no law that requires an heir to accept a net liability. But if the underlying property is accepted by the heir, the issues change.
Anonymous

Again, at a maturity event in situations where outstanding loan balance (fees and charges) exceed fair market value of the subject property, no debt is “forgiven” on an FHA insured HECM. The lender is made whole from insurance proceeds for which the borrower paid substantial upfront and ongoing costs. This is not debt forgiveness! Otherwise, what is PMI for?rn
Anonymous

Mr. Veale,rnrnHas the trust ownership strategy happened in actual practice yet?rnHas any heir disclaimed and successfully avoided tax on the gain?rnrnThanks
Anonymous

“A good planning technique is having a revocable trust own the home that is security for a reverse mortgage as long as that is the only asset held by that particular trust.”rnrn- Good advice.
Anonymous

James,rnrnTwo people who had a bank paying them on a reverse mortgage have died, that property is going to sale thru the public trustee and I want the property and have been looking very hard at the neighborhood. brief info, property purchased by bank in 06 for 392k, remaining balance of the reverse is roughly $255k, property is probably worth 392k or more, there is a law office for the bank involved, shouldn’t the bank continue payments to heirs? would the bank want the money they’ve paid out back, the money they haven’t paid out, both or fair market value and legal fees? I’ll watch for posts and I will try to find a contact number for you…. Also, given the tax consequences, I could try to find the decedants ex-POA who was on the account prior to death and with the same name could be the heir to receive the tax bill if there is one… confusing and I’ve been in Financial Services for 18 years…. sTEVE
Anonymous

The decedent had taken out a reverse mortgage on her home. The bank is now trying to sell the home, but in this economy the bank may not recoup the mortgage amount. If the bank issues a 1099C, is this taxable income to the estate. Cancellation of debt is not taxable on qualified personal residences due to the The Mortgage Debt Relief Act of 2007. The heirs have not and do not plan on taking ownership of the home. rnThe estate attorney is concerned that the estate will owe taxes if a 10999C is issued. I can’t seem to find anyone who knows the answer. Any thoughts?
Anonymous

Another point is that in buying the house, the contract notes that I will be responsible for paying off the reverse mortgage lender.rnTaylor DDS
Anonymous

Thank you for your reply, sir. I will pass it on to my accountant. Interestingly both he and the estate’s accountant feel it should be deductible by me. However I haven’t been totally confidant in this and to be honest, everyone else I’ve contacted has been very vague, and I’ve checked with some (I think…) top tax people in my area. Can you suggest someone in the Dallas/Fort Worth area? ThanksTaylor
Anonymous

While this is an interesting question, it is also a question inviting malpractice. I will provide some general guidance but your question did not provide specific enough information to begin to address the many layered issues it brings up. rnrnYou need the help of an income tax advisor who is familiar with estate income tax and real estate laws within the state where the property is located and also estate law and estate income tax law where the estate is domiciled if it is different. Such advisor should be: 1) competent, 2) knowledgeable regarding the specific type of reverse mortgage involved, estate income tax law, and interest deduction rules applied to both the period that the estate owned the home and then separately as to the decedent and that personu2019s ownership of the property, and 3) experienced in such matters.rnrnWhat is clear is that Internal Revenue Code Section 691(b) controls the allocation of the deductible portion of accrued but unpaid interest due as of the date of the death of a decedent. To the extent that the estate receives the deduction, it must deduct it. In the year of termination, excess deductions are allocated to heirs. rnrnNo part of the interest deduction accruing before the sale goes to the purchaser of the home based solely on the purchase. Such interest goes to the estate, if the estate held title due to the passing of the decedent. Of course if the home was specifically devised in a will to the subsequent title holder and such devise was required to be immediate, that will generally have a different result as to the devisee depending on state law. Then there is also the question of disclaimer but that exceeds any answer that should be provided in this setting.rnrnThere are many types of reverse mortgages. I know of no reverse mortgage that is a recourse debt. If it is not due and payable, the purchaser takes title in the property u201csubject to theu201d reverse mortgage. The only way that could be true, however, is if at least one original borrower is alive, still holds an interest in title in the home, and lives in the home as the principal residence of that person. rnrnIn an acquisition, accrued interest that accrued before acquisition is never deductible by the acquirer, only by the seller. It is only the person who legally had the obligation to repay it or if more than one obligor, as agreed and permitted by the tax law.rnrnInternal Revenue Code 691(b) allows deduction of interest to the extent that the decedent could have deducted it if the amount had been paid in full immediately before death. If the deduction is a result of u201cexcess deductions on terminationu201d from an estate, the deduction can only be taken as an u201cother deductionu201d on Form 1040 Schedule A subject to the 2% floor and is not deductible for alternative income tax purposes. rnrnIf the deduction is paid in a year other than termination and the property was owned by the estate at any time following the death of the decedent, then only the estate can deduct the interest and if it could only have been deductible as home mortgage interest by the decedent and the total deductions (such as the home mortgage interest) exceed net income from all sources, the excess is generally lost; it cannot be carried forward or carried back.rnrnOf course different rules could apply to a principal residence whose title was held by a revocable trust. rnrnAgain it is highly recommended to seek the help of a professional tax advisor as described above. This answer was not intended to provide specific advice and therefore, cannot be relied upon to mitigate any penalties that the IRS might assess.
Anonymous

If an heir buys the house with the reverse mortgage and assumes the debt in agreement with the other heir(s) can the heir-buyer deduct the reverse mortgage interest on the deceased parent’s 1098 if the deduction is flowed to that heir with a K-1 from the parent’s estate tax return?
Anonymous

dduck12,rnrnThis is why whether you are right or not or some type of exemption applies in NYC, it is important for those are considering getting a reverse mortgage to seek the advise of a tax advisor who is competent, knowledgeable, and experienced in such matters in the locality where the property is located. This also applies to those who are considering restructuring ownership so as to minimize any income or estate tax liability. In some localities, a change in title can result in a property tax reassessment. In California as long as the owners of the property are the trust beneficiaries, exemptions generally apply.rnrnWhile life insurance or a sinking may be a good alternative, insurable caps and other factors could come into play along with exposure of the life insurance proceeds to inclusion in a taxable estate increasing an estate tax liability, if any.rnrnI am glad you brought this up. Getting competent advice on such matters is very important.rnrn
Anonymous

Some additional information regarding using a revocable trust, pertinent at least in NYC and NY State but hopefully not in other jurisdictions. (One should check local laws on this.) There may be an out of pocket cost, in addition to the drafting cost of the trust; it could be substantial. It is a transfer tax quoted from this web site:rnrnhttp://www.docstoc.com/docs/3274615/New-York-City-Real-Property-Transfer-Tax-NEW-YORK-CITYrnrnNew York City Real Property Transfer TaxrnNEW YORK CITY REAL PROPERTY TRANSFER TAX Regulations on Continuing Lien Exclusion From Consideration Regulations on the Change of Identity or Form of Ownership or Organization Exemption and Transfers of Controlling Economic Interests Form NYC RPT and Instructions1% If Consideration Is Less Than $500,0001.425% If Consideration Is Greater than $500,000 For The Following Transfers:Conveyances where the real property transferred or the real property in which the economic interest transferred is a one, two or three family house, an individual cooperative apartment, an individual residential condominium unit or an individual dwelling unit in a dwelling which is to be occupied as the residence or home of four or more families living independently of each other,and Grants, assignments or surrenders of leasehold interests in a one, two or three family house, or an independent dwelling unit in a dwelling which is to be occupied or is occupied as the residence or home of four or more families living independently of each other.Other Transfers:1.425% If Consideration is $500,000 Or Less$2.625% If Consideration Is Greater Than $500,000(Special Rate For Transfers to REITS)Note: New York State Tax Law, Section 1201(b) and Section 11-2102 of the Administrative Code of the City of New York have been amended effective August 28, 1997 to allow for the City’s Real Property Transfer Tax a continuing lien deduction from consideration on the transfer of a one, two or three family house, an individual residential cooperative or condominium unit, or an economic interest in such property if the lien continuing existed before the date of transfer. The deduction will not be allowed on a transfer to a mortgagee, lienor or encumnbrancer or to a REIT. A Bulletin of the New York City’s Department of Finance on the application of this deduction is anticipated.Tax must be paid within 30 days of the date of transfer or interest and penalties will be assessed. Tax is payable by the Transferor but there is Transferee liability.rnrnSo, if I am correct, transferring a $500,000 property would cost $5,000 in taxes to NYC and I believe another $4 per thousand to NY State, or $2,000; total $7,000. I hope I am wrong and this does not apply to a Revocable Trust.rnAn alternative, if available and practical, would be either life insurance or a sinking fund to pay for the potential tax liability of a short sale.
Anonymous

You have to watch these east coast governors carefully.rnrngood weekend to all.
Anonymous

dduck12,rnrnHOA stands for Homeowners’ Association. This shows I have less knowledge about NYC coops than I thought. Where the former governor went.rnrnHave a great weekend.
Anonymous

Mr. VealernrnI was forced to become a 12 by the the new forum system. Like the government, the internet is all powerful. rnI see that some careful coordination among a will (hopefully, most people have one) a single asset trust (and a possible other trust) is needed. rnMy main concern now is for the advent of co-ops being eligible for HECMs and the inevitable skepticism of co-op boards. I personally ran a trial balloon in my building and the main financial guy, a CPA who also specializes in financial planning did not do back flips in anticipation of RMs for co-ops. I also went to a CE meeting this week and one subject was retirement planning and sources of income. I added that in some cases an RM could be very useful. As it happens, one of the other attendees was involved with the Council of New York Cooperatives and Condominiums, and they are discussing RMs. He also expressed concern that there were scammers out there pushing proprietary RMs and that fees for RMs in general were high. Clearly, RM originators will have to continue to educate and these people. But the point is, it would be nice to be able assure boards that there is some mechanism to pay the maintenance charges, otherwise they may not approve applications for RMs. I assume you have heard that some condos in Fla. have to chase banks for the condo fees on foreclosed units.rnBTW: I don’t know what a HOA is (it’s not what former Gov. Spitzer went to, is it?).rnI consider myself to be a concerned retiree and a member of the financial planning industry (we used to be insurance salesmen, when I frst started), and believe RMs are a useful planning tool and I am trying to educate people in my little universe. I have no official affiliation to the RM industry, just a fly on the wall.rnHowever, I would like to see more RM originator cross-pollination with CLUs, ChFCs, CFPs and financial planning CPAs. Perhaps Snoopy is working on that phase.rn
Anonymous

dduck12 (I am assuming you are AKA dduck),rnrnI appreciate and value your compliment.rnrnWe all hope you are right about short sales and even foreclosures. Like you I believe the horizon on home values is bright but when we get there is still uncertain.rnrnUnless it can be assured that there will be no other assets in the estate, it is hard to beat the single asset trust when it comes to reverse mortgages.rnrnTo the extent that payments are made directly to vendors, directives in a will or the governing document of another trust could handle those issues. To the extent payments must be made to or through a concerned HOA, why not set up some type of escrow account with 12 months of payments deposited into it? Any earnings would be paid to the borrower and the HOA would be paid until the property (or stock) is sold and could even be adjusted annually. Or the single asset trust could be expanded to add the cash needed to care for the situation since the income tax liability will not be reflected on a tax return for some time following the death of the borrower; of course, any cash not used for trust expenses will be subject to the claims of the IRS. If that does not satisfy the situation, the use of the single asset trust may not be practical. rnrnMost seniors in Southern California do not face HOA issues the way that seniors owning coops surrounding Central Park in NYC do. Some advisor dealing with HOA situations will probably provide a more satisfactory and practical answer.rnrnBy the way there is much specualtion among RMD readers about your involvement in the RM industry. By now if you are not already involved, you should be.
Anonymous

Mr. VealernrnOnce again I thank you for providing this forum with invaluable information.rnAs we all know, sometimes the devil is in the details. The trust route sounds right for cautious types like me. Chances are from this point, at least I hope so, given average borrower longevity, most properties will not be short sales. However, a revocable trust allows for much easier and less costly changes (like the beneficiary of a life insurance policy) than a writing a new will to change the successor designation.rnFor those that wish to honor their obligations, one point bothers me. If the trust has no money for the tax people, it also does not have any to continue property taxes, insurance, condominium or co-op (hopefully, soon) costs. Who pays and how? As far as a condo or coop, I think the boards would be concerned about this. It could take a while for a sale to take place, or does the bank sell very quickly in real life because of the FHA “insurance”? rn(BTW, I’m assuming that under an estate situation, the estate would/could pay these costs.)
Anonymous

Mr. B,rnrnThe circumstances causing the note to become due will not impact the tax result of selling a home for less than the amount due on a non-recourse debt. Such a sale is generally referred to as a short sale and is included in the word u201cforeclosureu201d as that word is used in each article. As long as the net sales proceeds are insufficient to pay off the balance due on a non-recourse debt, debt is cancelled resulting in additional taxable proceeds beyond the actual sales price.rnrnAgain if the borrower is alive, gain or loss results from the sale of the security based on the rules described in the first article. If the borrower has passed away at the time of sale, the rules described in the article above apply and normally result in gain.rn
Anonymous

Still have a question?rnWhen a reverse mortgage note becomes due because the senior is no longer living there or is deceased but the home is sold for market value. Would this avoid the tax situation on any debt forgiveness?
Anonymous

dduck12,rnrnYou are right. Heirs can also disclaim in other trusts or an estate; however, an income tax liability still results and the estate or trust must pay that liability from its other assets. However, the technique suggested in the article avoids the payment of that liability.rnrnFor example, a borrower places title of a home in a revocable trust in which there is no other asset. Following death, the trust beneficiaries determine that the balance due on the RM is greater than the homeu2019s value and that the tax detriments far outweigh the tax benefits. As a result all of the heirs disclaim. Now the trustee prepares the trust income tax return and determines an income tax liability is due. The trustee and the IRS look for other assets of that trust and determine that there never were any. Without other assets, the IRS cannot collect payment. Thus the income tax liability will be forgiven and is legally avoided.rnrnIf the same situation existed and there was a $100,000 certificate of deposit also owned by that same trust, the IRS would have the right to collect income tax liability related to the foreclosure from the $100,000 certificate of deposit or if the trustee had distributed all of the money, the IRS would collect it from the trustee or heirs, whatever is ultimately easiest for the IRS.rnrnI hope that explains why this technique is so effective.rnrnAs to a charity, it all depends on the type of entity involved. If it is in an estate, a charity could not accept an asset with a liability exceeding its value. The same would hold true with a typical living trust. A charitable remainder trust is generally much different; however, a lot more detail is needed to adequately address your question.rnrnAgain my answer does not constitute opinion upon which the reader can rely on to mitigate tax penalties. Readers are advised to seek the tax advice of a competent and knowledgeable tax consultant who is experienced in such matters.
Anonymous

Mr. Stengel,rnrnIt is very clear that you and I view FHA mortgage insurance and PMI very differently. Even though I believe that the tax results are the same. So what is PMI?rnrnPMI is defined by the Federal Reverse Bank of San Francisco (u201cFRBSF, http://www.frbsf.org/publications/consumer/pmi.html) as follows:rnrnu201cPMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home’s value. In other words, buyers with less than a 20 percent down payment are normally required to pay PMI.u201drnrnPMI stands for private mortgage insurance and is nothing more than that. According to 12 USC Section 4901 (13) — (http://uscode.house.gov/download/pls/12C49.txt) — also known as the Homeowners Protection Act of 1998, private mortgage insurance is defined as follows: u201cThe term u2018private mortgage insuranceu2019 means mortgage insurance other than mortgage insurance made available under the National Housing Act [12 U.S.C. 1701 et seq.], title 38, or title V of the Housing Act of 1949 [42 U.S.C. 1471 et seq.].u201drn rnClearly FHA coverage is not PMI. Even the Internal Revenue Code (u201cIRCu201d) under Section (u201cu00a7u201d) 162(h)(3)(E)(ii) treats PMI as a separate category of mortgage insurance from FHA mortgage insurance which is classified under 162(h)(3)(E)(i). As explained to me by legal counsel, PMI is an actual insurance policy with all the terms, etc. explained in the policy. FHA HECM insurance on the other hand is a body of law that provides guarantees to those who qualify and participate.rnrnWhy the FHA coverage? Because no mortgagee would ever provide a loan based on such permissive terms without it. When you try to find its closest significant competition you find they all dried up. Why? Because they could not be profit justified even with their less generous terms.rn rnA HECM is non-recourse and the line of credit adjusts upwards (and sometimes slightly downwards) based on the increase in the principal limit, the decrease in the unamortized servicing fee set aside, the balance due and if applicable, other payout terms, and possibly, other factors such as a repair set aside. Tenure payments (if all covenants continue to be abided by) continue until the loan matures. Even term payments reflect a projected growth in the principal limit. The loan stays in force for as long as the covenants are met and thus the borrower can freely live in the home throughout that period. For home values under the HECM lending limit, there never has been any other reverse mortgage product with such high principal limits to maximum claim amounts. It provides wonderful consumer benefits but there are upfront costs.rn rnThe reasons for the FHA coverage are economic to encourage mortgagees to offer them; they are not tax.rnJust because a loan is paid in full does not mean the borrower paid it off. The HECM loan is non-recourse but not because FHA insurance pays it off. It is because the note itself must be non-recourse for the mortgage to qualify as a HECM.rnrnOne is free to make your equity argument but it is not based on anything found in tax law. For those who are less acquainted with the taxation of insurance proceeds, your argument is persuasive. However, it is not correct. All insurance proceeds are subject to income tax unless specifically excluded by the IRC, such as life insurance to the extent provided by IRC u00a7 101 and most medical insurance by IRC u00a7 104. IRC u00a7 1033 dealing with involuntary conversions is a common source of taxation of insurance proceeds.rn rnThe payment of the amount unsatisfied from foreclosure under a non-recourse loan is not a benefit to the mortgagor — that amount is forgiven by the note itself; it is only a benefit to the mortgagee. Whether the mortgagee is paid by FHA or not, as to the mortgagor the loan is deemed paid in full in foreclosure, period — because the underlying note itself is non-recourse.rnrnI hope that answers your excellent questions.
Anonymous

Mr. Veale,rnrnSorry for being dense, but isn’t disclaiming under a will, where an heir is named as a successor to the property, the same as disclaiming under a trust?rnI suspect there might be other estate planning reasons for using the trust route.rnIt would be interesting to know if there are. Perhaps a lawyer using the trust route would care to comment.rnAlso, If the intended successor is a charity, am I correct that the tax issue is a mute point?
Anonymous

dduck12,rnrnI have heard of one law firm that was creating such trusts before I even began discussing them. In Los Angeles at the last NRMLA national convention, an attorney representing a title company recommended using such trusts for other issues.rnrnYes, heirs have disclaimed to avoid such tax; however, I know of no such case involving reverse mortgages. Again I do know attorneys who regularly use this technique.rnrnThere is no law that requires an heir to accept a net liability. But if the underlying property is accepted by the heir, the issues change.
Anonymous

Again, at a maturity event in situations where outstanding loan balance (fees and charges) exceed fair market value of the subject property, no debt is “forgiven” on an FHA insured HECM. The lender is made whole from insurance proceeds for which the borrower paid substantial upfront and ongoing costs. This is not debt forgiveness! Otherwise, what is PMI for?rn
Anonymous

Mr. Veale,rnrnHas the trust ownership strategy happened in actual practice yet?rnHas any heir disclaimed and successfully avoided tax on the gain?rnrnThanks
Anonymous

“A good planning technique is having a revocable trust own the home that is security for a reverse mortgage as long as that is the only asset held by that particular trust.”rnrn- Good advice.
http://financialstabilitytrust.org/ Johanne

“A good planning technique is having a revocable trust own the home that is security for a reverse mortgage as long as that is the only asset held by that particular trust.”

- Good advice.
dduck12

Mr. Veale,

Has the trust ownership strategy happened in actual practice yet?
Has any heir disclaimed and successfully avoided tax on the gain?

Thanks
Jim Stengel

Again, at a maturity event in situations where outstanding loan balance (fees and charges) exceed fair market value of the subject property, no debt is “forgiven” on an FHA insured HECM. The lender is made whole from insurance proceeds for which the borrower paid substantial upfront and ongoing costs. This is not debt forgiveness! Otherwise, what is PMI for?
James E. Veale, CPA, MBT

dduck12,

I have heard of one law firm that was creating such trusts before I even began discussing them. In Los Angeles at the last NRMLA national convention, an attorney representing a title company recommended using such trusts for other issues.

Yes, heirs have disclaimed to avoid such tax; however, I know of no such case involving reverse mortgages. Again I do know attorneys who regularly use this technique.

There is no law that requires an heir to accept a net liability. But if the underlying property is accepted by the heir, the issues change.
dduck12

Mr. Veale,

Sorry for being dense, but isn't disclaiming under a will, where an heir is named as a successor to the property, the same as disclaiming under a trust?
I suspect there might be other estate planning reasons for using the trust route.
It would be interesting to know if there are. Perhaps a lawyer using the trust route would care to comment.
Also, If the intended successor is a charity, am I correct that the tax issue is a mute point?
James E. Veale, CPA, MBT

Mr. Stengel,

It is very clear that you and I view FHA mortgage insurance and PMI very differently. Even though I believe that the tax results are the same. So what is PMI?

PMI is defined by the Federal Reverse Bank of San Francisco (“FRBSF, http://www.frbsf.org/publications/consumer/pmi….) as follows:

“PMI is extra insurance that lenders require from most homebuyers who obtain loans that are more than 80 percent of their new home's value. In other words, buyers with less than a 20 percent down payment are normally required to pay PMI.”

PMI stands for private mortgage insurance and is nothing more than that. According to 12 USC Section 4901 (13) — (http://uscode.house.gov/download/pls/12C49.txt) — also known as the Homeowners Protection Act of 1998, private mortgage insurance is defined as follows: “The term ‘private mortgage insurance’ means mortgage insurance other than mortgage insurance made available under the National Housing Act [12 U.S.C. 1701 et seq.], title 38, or title V of the Housing Act of 1949 [42 U.S.C. 1471 et seq.].”

Clearly FHA coverage is not PMI. Even the Internal Revenue Code (“IRC”) under Section (“§”) 162(h)(3)(E)(ii) treats PMI as a separate category of mortgage insurance from FHA mortgage insurance which is classified under 162(h)(3)(E)(i). As explained to me by legal counsel, PMI is an actual insurance policy with all the terms, etc. explained in the policy. FHA HECM insurance on the other hand is a body of law that provides guarantees to those who qualify and participate.

Why the FHA coverage? Because no mortgagee would ever provide a loan based on such permissive terms without it. When you try to find its closest significant competition you find they all dried up. Why? Because they could not be profit justified even with their less generous terms.

A HECM is non-recourse and the line of credit adjusts upwards (and sometimes slightly downwards) based on the increase in the principal limit, the decrease in the unamortized servicing fee set aside, the balance due and if applicable, other payout terms, and possibly, other factors such as a repair set aside. Tenure payments (if all covenants continue to be abided by) continue until the loan matures. Even term payments reflect a projected growth in the principal limit. The loan stays in force for as long as the covenants are met and thus the borrower can freely live in the home throughout that period. For home values under the HECM lending limit, there never has been any other reverse mortgage product with such high principal limits to maximum claim amounts. It provides wonderful consumer benefits but there are upfront costs.

The reasons for the FHA coverage are economic to encourage mortgagees to offer them; they are not tax.
Just because a loan is paid in full does not mean the borrower paid it off. The HECM loan is non-recourse but not because FHA insurance pays it off. It is because the note itself must be non-recourse for the mortgage to qualify as a HECM.

One is free to make your equity argument but it is not based on anything found in tax law. For those who are less acquainted with the taxation of insurance proceeds, your argument is persuasive. However, it is not correct. All insurance proceeds are subject to income tax unless specifically excluded by the IRC, such as life insurance to the extent provided by IRC § 101 and most medical insurance by IRC § 104. IRC § 1033 dealing with involuntary conversions is a common source of taxation of insurance proceeds.

The payment of the amount unsatisfied from foreclosure under a non-recourse loan is not a benefit to the mortgagor — that amount is forgiven by the note itself; it is only a benefit to the mortgagee. Whether the mortgagee is paid by FHA or not, as to the mortgagor the loan is deemed paid in full in foreclosure, period — because the underlying note itself is non-recourse.

I hope that answers your excellent questions.

Tax Consequences Resulting from Foreclosure on a Reverse Mortgage (Part 2)

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