Two More Key Reverse Mortgage Tax Resources

The jury’s still out on how tax reform could affect reverse mortgage borrowers — and the prevailing consensus could simply be that each homeowner’s mileage may vary based on his or her specific circumstances.

But for an even deeper dive into the implications of the 2017 Tax Cuts and Jobs Act (TCJA), check out these two resources from prominent retirement bloggers.

Over at Tools for Retirement Planning, writer Tom Davison highlights some of the key changes that could affect those Home Equity Conversion Mortgages — particularly the disappearance of deductions for home equity interest.

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Still, the end of the deduction isn’t quite so clear-cut, as Davison points out: Homeowners who take advantage of the HECM for Purchase program can still deduct their interest because that counts as “acquisition debt.” Those who take out HECMs agains their existing homes for cash flow in retirement, meanwhile, can no longer claim those deductions.

“The determination of ‘home equity indebtedness’ vs. ‘acquisition indebtedness’ is based on how the mortgage proceeds are used,” writes blogger Michael Kitces in his own exhaustive breakdown of the TCJA.

Kitces notes that the deductible “acquisition debt” also applies if the mortgage is used to build or “substantially improve” one’s primary residence, and that only the first $750,000 of debt principal can be written off.

“A HELOC that is used to build an expansion on a house is still treated as acquisition indebtedness (as it was used for a substantial improvement), while a cash-out refinance of a traditional 30-year mortgage used to repay credit cards will be ‘home equity indebtedness’ for the cash-out portion,” Kitces wrote.

Furthermore, the new rules only apply to loans taken out after last December 15, Kitces emphasizes, with homeowners still able to deduct interest on the first $1 million of debt principal for all mortgages originated prior to that date.

Written by Alex Spanko

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  • Is that what Mr. Kitces actually said? It is doubtful.

    The article above states: “Kitces notes that the deductible “acquisition debt” also applies if the mortgage is used to build or ‘substantially improve’ one’s primary residence, and that only the first $750,000 of debt principal can be written off.”

    None of the debt principal can be written off, period. It is only the interest related to acquisition indebtedness. Acquisition indebtedness is generally the mortgage proceeds used to acquire, construct (including additions) or substantially improve the home subject to a limitation.

    HOWEVER, the quotation attributed to Mr. Kitces ignores the largest possible portion of acquisition indebtedness whose related interest is deductible (in a few cases without limitation) and that is “any indebtedness secured by such residence resulting from the refinancing of indebtedness meeting the requirements of the preceding sentence (or this sentence); but only to the extent the amount of the indebtedness resulting from such refinancing does not exceed the amount of the refinanced indebtedness.” The preceding sentence referenced in the quotation is the following portion of Internal Revenue Code Section 163(h)(3) which reads as follows:

    (B) Acquisition indebtedness

    (i) In general,

    The term “acquisition indebtedness” means any indebtedness which—

    (I) is incurred in acquiring, constructing, or substantially improving any qualified residence of the taxpayer, and

    (II) is secured by such residence.”

    But the misinformation does not stop there. The article goes on to say: “Still, the end of the deduction isn’t quite so clear-cut, as Davison points out: Homeowners who take advantage of the HECM for Purchase program can still deduct their interest because that counts as ‘acquisition debt.’ Those who take out HECMs agains their existing homes for cash flow in retirement, meanwhile, can no longer claim those deductions.” (Sic)

    It is not the interest that is “acquisition debt” but rather the proceeds (including those refinanced as permitted above) that were used to acquire, construct or substantially improve the home that are acquisition indebtedness. This is crucial in that Dr. Barry Sacks claims that interest on interest is not deductible as acquisition indebtedness since only proceeds used as specifically defined are classifiable as acquisition indebtedness. Here is where you can find the article by Dr. Sacks; however, be aware that the article does not reflect changes mandated by the 2017 Tax Act:

    https://tcbdavison.files.wordpress.com/2016/04/sacks-et-al-recovering-a-lost-deduction-in-journal-of-taxation-april-2016.pdf

    Other limitations still apply. Dr. Davison correctly points out: “Refinancing does not change the type of debt: if you refinance acquisition debt, it remains acquisition debt.” See his article titled “Major changes in Tax Deductions for Reverse Mortgages: December 2017 Update.” at

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

    Dr. Davison does go wrong by stating that interest on a HECM for Purchase are deductible. That is only true on the interest of the proceeds that OTHERWISE meet the 1986 Internal Revenue Code Section 163(h)(3)(B) definition. In fact in certain cases none of the interest even on a HECM for Purchase may be deductible. Also interest on both traditional and refinanced HECMs remains deductible to the extent it is related to acquisition indebtedness.

    Although it could be corrected in the future as it has been the case for a number of years now, FHA MIP related to HECMs is no longer deductible after 2017 as required under 1986 Internal Revenue Code Section 163(h)(3)(E)(iv). Even when MIP was deductible it was only permitted to the extent it applied to acquisition indebtedness.

      • REVGUYJIM,

        There is no FHA requirement that even one dime of HECM proceeds be used to pay for the acquisition of a home. In fact H4P was designed to remove the duplicative costs of acquiring the collateral and then originate a HECM AFTER the collateral is acquired.

        So let us say that a senior is using the Standby HECM strategy and has no intent of using more than 60% of the proceeds in the first year following origination. The senior also wants maximum growth in the line of credit so escrow closes simultaneously on the collateral and HECM.

        Let us say that over the years none of the proceeds were used to 1) acquire, 2) make additions on the home, or 3) substantially improve the home. Proceeds were used, however, in mitigating losses from the risk of the sequence in returns.

        In the foregoing case, none of the interest can be classified as interest as home acquisition indebtedness. Perhaps some of the interest can be classified as deductible as investment income interest expense but that subject exceeds the time and space available to the writer.

      • The example you give, using the “Standby Strategy”, is not a HECM for Purchase transaction. By definition the latter involves the acquisition of the home and as such should be eligible for interest deduction.

        Since your example is not a HECM for purchase transaction, I still do not understand your original statement that “.. in certain cases none of the interest even on a HECM for Purchase may be deductible.” I can not think of such a case.

      • REVGUYJIM,

        Your definition seems quite contrived and is not consistent with Mortgage Letter 2008-33 which states:

        “The Federal Housing Administration (FHA) defines ‘HECM for Purchase’ as a real estate purchase where title to the property is transferred to the HECM mortgagor, which the mortgagor will
        occupy as a principal residence, and, at the time of closing, the HECM first and second liens will be the only liens against the property. HECM mortgagors must occupy the property within 60 days from the
        date of closing. Lenders are required to ensure all outstanding or unpaid obligations incurred by the
        prospective mortgagor, in connection with the HECM transaction, are satisfied at closing.”

        The term, HECM for Purchase,” is also defined in new regulation 24 CFR 206.45(g)(1) as follows:

        “A HECM for Purchase transaction is where title to the property is transferred to the HECM
        borrower and, at the time of closing, the HECM first and second liens, if
        applicable, will be the only liens against the property.”

        Unless you have an official HUD document that states otherwise, there is no requirement that even one penny of the proceeds be used to purchase the home. Please discuss the transaction with those who have some experience with it.

        The dominating principal justifying the HECM for Purchase legislation was the avoidance of duplicative costs from two distinct closings which could be easily eliminated through a HECM for Purchase product. Please justify what seems to be a contrived definition.

        It is hard enough in this industry to discuss issues but then add those who will not do their “research homework” before making claims about definitions, etc. and you have what appears to be a significant number of industry originators who appear to be very ignorant about their own products.

      • An interesting, but typical, response.

        Can I then expand without changing the meaning of your original comment to read, ‘In fact in certain cases where none of the proceeds are actually being used for the purchase of the property, none of the interest even on a HECM for Purchase may be deductible.’

        While feasible, I would welcome a post from an originator who has actually facilitated such a transaction. Thanks to you, Mr. Veale, for bringing to light another creative use of the HECM program.

      • REVGUYJIM,

        It is inside the box thinking as expressed in your last reply (particularly in its last paragraph) that shows why there is so little growth in differing legitimate uses of HECMs to meet the goals of seniors.

        The industry as a whole espouses the idea that if the objective of senior is to grow the line of credit that they get a HECM at the earlier of now or at the time they turn 62. So for a senior who is over 62 and is looking at buying a new home, why not get the product at that point?

        If no originator has closed a H4P for this purpose that either shows seniors could care less about a growing line of credit and saving on costs with a H4P or originators are lost in terminology just the way you have demonstrated.

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