What the New Tax Law Means for Reverse Mortgage Borrowers

American taxpayers and accountants are still sorting out the effects of the wide-reaching Republican-led tax overhaul, and the ramifications could be severe for reverse mortgage borrowers — or nonexistent, depending on who you ask.

One key problem could potentially arise from new rules regarding the deduction of state and local taxes (SALT) from federal returns, which had been a key lifeline for homeowners of all ages in certain high-tax states such as New York, New Jersey, and California.

Under the old tax structure, homeowners could deduct the entire amount of their property taxes from their federal bills — a boon to residents of certain places like suburban Nassau County, N.Y., where average property taxes could run higher than $11,000 for even a median-priced home worth about $511,000.

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But the new tax caps the SALT deduction at $10,000 for income, property, and sales taxes combined, which could lead to a substantial overall tax increase for those homeowners. Rep. Tom Suozzi, a Democrat who represents higher-income areas in Nassau County, wrote to the Internal Revenue Service asking the agency to allow deductions for 2018 tax payments made in 2017, Long Island newspaper Newsday reported; the IRS indicated that prepaid taxes could indeed be deducted, but only if they were assessed and paid before the new year.

Residents of Nassau and neighboring Suffolk County lined up in droves during the final days before January 1, with some town tax collectors extending their hours and remaining open on New Year’s Eve, a Sunday — all so residents could voluntarily pay their 2018 taxes in advance.

The reverse impact

For reverse mortgage borrowers, property taxes represent a major chunk of ongoing payment obligations, along with homeowner’s insurance. At least one consumer advocate, foreclosure defense lawyer Joshua Denbeaux, has warned that capping SALT deductions could have an adverse impact on seniors with Home Equity Conversion Mortgages.

“I am going to see more clients,” said Denbeaux, a partner at the firm of Denbeaux & Denbeaux in Westwood, N.J. “I know that for a certainty.”

Denbeaux, who also wrote an editorial for The Hill expressing his concerns, said a substantial amount of New Jersey homeowners have annual property tax bills in excess of $10,000.

“When you’re on a fixed income and you have to cover the tax bill, and it goes up by whatever percent — you’ve got a big financial hit that you weren’t expecting, and none of the people who come to me have the flexibility to adjust to it,” Denbeaux told RMD.

But professionals in the HECM industry pushed back on the concerns. Tom Holsworth, vice president of reverse mortgage lending at the Queens, N.Y.-based Quontic Bank, said some higher-end HECM borrowers could end up coming out ahead overall thanks to the automatically higher standard deduction — which nearly doubled for married couples filing jointly, rising from $12,700 to $24,000.

“The impact to those [borrowers] would be case-by-case, but I say the impact would be minimal by the time they claim their…deductions,” Holsworth told RMD.

Still, Holsworth also cautioned that much remains up in the air.

“It’s a case-by-case [basis], and there certainly will be an impact. Whether it’s positive or negative yet, I’m not real certain for any client,” he said.

Laurie MacNaughton, a reverse mortgage consultant with Atlantic Coast Mortgage in the Virginia suburbs of Washington, D.C., said that the financial pressures affecting her clients outweigh the potential negative effects of tax reform.

“Many of my clients live in high-property-tax-jurisdictions and are in homes valued far above the national average,” MacNaughton told RMD. “However, most have exhaustively weighed and considered their options — and the cost of those options — and have decided a reverse mortgage is the best among those options.”

“The vast majority of my clients are referred to me by legal professionals or wealth managers, and most of my homeowners are working in concert with adult children. Property tax deductibility and the new tax laws are not going to have a severe impact, as other financial considerations are going to remain far more pressing,” she said.

Written by Alex Spanko

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  • As a CPA I had three clients who paid over $500,000 annually just in California income taxes and total SALT deductions of amounting to over $700,000. Their increase in federal income tax (net of the savings from a lower top federal income tax rate) will exceed $140,000. At least one other who lives in a state where there is no state income tax but pays over $300,000 in other SALT taxes will see a decrease in federal income tax of about $15,000.

    Yet I have little concern about SALT deductions when it comes to the reverse mortgage borrowers. It is the loss of home equity indebtedness interest that will have the greatest potential impact on these loans.

    For many reverse mortgage borrowers, there will be no income tax deduction for the accrued interest on the HECM for either borrowers or heirs as a result, no matter when the interest is paid, unless it was paid before 1/1/2018. This is not true for acquisition indebtedness (as specifically defined) but will be limited for some with the maximum amount of this type of indebtedness now being limited to $750,000 on debt incurred after 12/15/2017 (for those who believe that compounded interest is deductible).

    Unfortunately, too many think they understand the use of debt and its related tax treatment but in fact do not. For years, the big tax ideas were centered around HECM proceeds as nontaxable income and the line of credit as some odd idea about it being interest. It seems a lot of this incorrect information was designed to deflect from the fact that reverse mortgages are nothing more than nonrecourse mortgage with special features for eligible seniors.

    • Jim,

      I agree with your analyses completely!

      As far as the new tax bill, very few actually know the entire details of the bill. Happy New Year my friend!

      John

    • Here are a few solutions for your 3 clients who paid more than $500,000 in California taxes. Only seven states lack an income tax altogether: Alaska, Florida, Nevada, South Dakota, Texas, Washington and Wyoming. Tennessee and New Hampshire fall into a gray area. They tax only dividend and interest income, not earned income. Some of these states do have above average property taxes and sales taxes, but a few, like Texas, Alaska, and Wyoming run their governments largely from oil, gas, and mineral royalties. There’s a reason why many highly paid Hollywood celebrities have chosen not to live in California.

      • Ctaj,

        You would be smart, if you learned your subject matter before you wrote. You obviously have no idea what you write.

        If a Hollywood celeb works in California for even one day, they pay California income taxes on the compensation they receive due to their efforts. Over a century ago, California due to help from New York City learned to tax compensation earned in California. Then under Governor Reagan, the state decided to tax that compensation through withholdings. There is a California Franchise Tax Board Agents section whose principal activities are to watch for entertainment activities in the state to ensure CA gets its share of income taxes. So you are only about a century behind the times.

        If you think Texas runs it state without corporate “franchise” tax (that is also the name of corporate taxes in California) that is triggered largely from corporate earnings, you are badly mistaken. If you think real estate taxes in Texas are cheap, let me introduce you to my friend who pays over five times as much in real estate taxes on a property worth one-quarter the value of the home I live in California. I would talk about the other states but I would be off the mark if I did. Also sales tax is not low in Texas.

  • Does anyone know whether interest repaid on a HECM is still tax deductible? I have clients who use the HECM like a mortgage and make monthly payments. If anyone has a definitive answer on this, please let me know.

      • Ctaj,

        What nonsense.

        Revenue Ruling 80-248 deals with the tax year of deduction for most reverse mortgage borrowers, not its deductibility since it precedes such change in the 1987 Tax Act (which like all subsequent tax acts, amends the so called “1986 Internal Revenue Code”) where limitations were first made to home mortgage interest. Unlike HUD rules, IRS Revenue Rulings cannot take precedence over income tax laws. If the type of home mortgage interest is not acquisition indebtedness as defined in the 1986 Internal Revenue Code Sections 163(h)(3)(A) and 163(h)(3)(B) most likely it will be nondeductible after 2017 until tax year 2026 as mandated under the 2017 Tax Act.

        Home equity indebtedness interest as defined in the 1986 Internal Revenue Code Sections 163(h)(3)(A) and 163(h)(3)(C) will not be deductible in tax years 2018 through 2025 as described in Public Law 115-97 (commonly called the 2017 Tax Act), Section 11043 which adds subsection 163(h)(3)(F) to the existing 1986 Internal Revenue Code Section 163(h)(3) which suspends the deduction of home equity indebtedness interest for a period of 8 years starting with tax year 2018.

        During tax years 2018 through 2025, few HECM taxpayers will be able to deduct any of the HECM interest they pay unless that interest is

        1) classifiable as acquisition indebtedness interest as defined in 1986 Internal Revenue Code Section 163(h)(3)(B) or

        2) deductible due to the use of the related proceeds in a tax activity where interest is otherwise tax deductible.

        BUT borrowers should seek the advice of their income tax advisers, especially as to planning around the 8 year period related to certain 2017 income tax changes.

  • There is more to the story on tax changes:

    Important income tax changes in December 2017 affect reverse mortgages. The Tax Cuts and Jobs Act (TCJA) of 2017 eliminated deductions for home equity interest starting in 2018. Deductions are still allowed for acquisition debt interest.

    Mortgage Insurance Premium (MIP) payments are not deductible after the 2016 tax year This was not due to the Tax Cuts and Jobs Act.

    Refinancing does not change the type of debt: if you refinance acquisition debt, it remains acquisition debt. Likewise refinanced home equity debt is still home equity debt.

    Acquisition debt: If you used a reverse mortgage to buy your home, the debt is acquisition debt and interest on it is deductible. A refinance example: when you were 50 you bought a home with a traditional mortgage. When you were 66, your cash flow was tight and you refinanced your loan with a reverse mortgage. Your old debt was acquisition debt so your new reverse mortgage is still acquisition debt. Any interest payments you make on it are deductible. (The interest deduction is limited to $750,000 of acquisition debt on new mortgages taken out after December 15, 2017. Mortgages taken out earlier retain their cap of $1,00,000 of acquisition debt).

    Home equity debt: Example: your old mortgage was paid off, and then you got a reverse mortgage, borrowing against the equity in your home. The reverse mortgage is home equity debt. Another example: After paying your mortgage off, you got a Home Equity Line of Credit (HELOC), also borrowing against your home’s equity. Later you refinance the HELOC with a reverse mortgage. This reverse mortgage is also home equity debt. No deduction is allowed on either of these two reverse mortgages for interest paid in 2018.

    A loan may have both home equity and acquisition debt. A “cash-out refinance” is a common example. Say you bought your home with a traditional mortgage: that’s all acquisition debt. After paying it down to $30,000 you refinance it with a reverse mortgage, taking out an additional $10,000 in cash. The initial balance of your reverse mortgage is $40,000: $30,000 of acquisition debt and $10,000 of home equity debt. When you make an interest payment 3/4 of it is for acquisition debt and is deductible. The remaining 1/4 of the payment is for home equity debt and, starting in 2018, is no longer deductible.

    An excellent summary of the Tax Cuts and Jobs Act changes by Michael Kitces is at his blog post Individual Tax Planning under TCJA Act of 2017.

    from: https://toolsforretirementplanning.com/2017/12/31/tax-deductions-and-reverse-mortgages-april-2017-update/

  • What minute percentage of HECM borrowers would be impacted? A nothing burger for our industry. The more vexing questions as outlined by Mr. Veale is the deductibility of paid interest.

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