The sweeping Tax Cuts and Jobs Act of 2017 changed much about the way that tax laws work in the United States, and also helped to elevate the reverse mortgage product category by enhancing its strategic importance for wealthy seniors seeking to incorporate a new element of strategy into their tax situations. This is according to Harlan Accola, national reverse mortgage director at Fairway Independent Mortgage Corporation in a column published at Nasdaq.
“[The 2017 tax law] has a profound effect on mortgage interest deductibility and actually elevated the reverse mortgage as an enhanced tool for strategic IRA withdrawals, Roth conversions, Net Unrealized Appreciation (NUA), and other strategies centered around deferred or accelerated tax accounts,” Accola writes.
In addition to unifying the standard tax deduction available to everyone regardless of whether a filer chooses to itemize or if they do or do not own a home, one major change focused on the one major deduction that remains allowed on mortgage interest: acquisition indebtedness, Accola explains.
“Formerly, home equity indebtedness interest was allowed to be deducted on a loan balance of $100,000 that was perhaps a Home Equity Line of Credit (HELOC) or 2nd mortgage,” he says. “So unless you are using the mortgage funds to build, buy, or substantially improve your home, interest is not deductible.”
Importantly, it doesn’t matter what kind of loan is in place for this purpose as long as the money is being, or has been used to either build or buy a new home, or to improve an existing home.
With a reverse mortgage line of credit in place during either a refinance or new home purchase and the full balance is drawn at closing, the line of credit continues to grow to account for the interest accrued on the money being used, Accola says.
“When any payment is made — even if it is only interest — the payment is first applied to the Mortgage Insurance Premium (MIP) and Interest expense before any principal is paid,” he says. “After the payment is made, within a few days, the full amount of the payment — regardless of how it was applied to the loan balance — is made available for the borrower to re-borrow from the line of credit the full amount that was paid.”
This is a strategy that can be used for as long as the client resides in the home, and they keep up with the property’s associated taxes and insurance fees. The line itself is guaranteed in spite of changes to the home value, and remains non-recourse, he says.
For strategic income tax or IRA purposes, letting interest accrue on a reverse mortgage for purchase transaction can let the interest accrue for several years, in which it will negatively amortize and increase the balance in the future.
In terms of accelerating taxes into a new lower rate environment, some advisors feel that the current moment represents the “lowest tax rate baby boomers will see in their lifetime,” Accola says. This means that the current moment could be the most optimal time to engage into a reverse mortgage to pay for taxes on a Roth IRA conversion, he explains.
“A reverse mortgage line of credit is tax free because it is borrowed money so withdrawals can be used at 100% of value to pay the tax due on a reverse mortgage,” he says. “Net Unrealized Appreciation (NUA) on company stocks for people retiring may make sense to be paid in the year they retire instead of over the next 20-30 years. Again the reverse mortgage can be used as a tax free source of funds to pay the lower taxes earlier.”
Read the column at Nasdaq.