Forbes: How Reverse Mortgages Can Affect Taxes in Retirement

For seniors who may feel squeezed by the necessity of paying taxes in retirement on a fixed income, there are a number of ways in which a senior might be able to reduce their tax burdens in retirement. One of the possible methods can include a reverse mortgage, according to financial planner Erik Carter in a new piece published at Forbes.

The employment of home equity is one such option for mitigating a tax burden, Carter writes, and you can do so simply by not leaving the home.

“There are several ways to get tax-free income from your home. One is to simply live in it,” Carter writes. “Your home is paying you income in the form of free rent, a concept called imputed rent. Fortunately, this ‘income’ is tax-free.”


Unlocking the equity may be a more correct solution, however, and for seniors wishing to explore that option they can look to something like a reverse mortgage, he says.

“You can also take a reverse mortgage against your home, which is just what it sounds like. Instead of you paying your mortgage company, the mortgage company pays you and it’s not considered taxable income,” he says. “You also get to keep your home as long as you live in it. However, when you move out or pass away, the home will be used to pay back the mortgage company plus fees.”

Some seniors may decide that another method could be more useful, such as downsizing by selling your existing home and moving into a smaller one.

“As long as you’ve lived in the home as your primary residence for two out of the last 5 years, you pay no capital gains tax on up to $250k of gain (or $500k for a married couple that files jointly),” Carter writes. “Like other investments, the home can also pass on to heirs with a step-up in cost basis, which can reduce or eliminate any tax on your lifetime gain if the property is sold.”

That’s not to say that a retiree will be able to entirely avoid a tax burden by using a reverse mortgage, however. Reverse mortgage industry educators Dan Hultquist and Jim McMinn touched on exactly that topic last year at the National Reverse Mortgage Lenders Association (NRMLA) Annual Meeting and Expo in Nashville, Tenn., noticing that some reverse mortgage companies advertise the loans as “tax-free” without elaboration.

“It’s always been marketed as that, I see it all the time,” McMinn said at the meeting. “When you’re getting a reverse mortgage, there could be taxes associated with that. We’ve got property taxes, recording taxes, intangible taxes, the list goes on. So, when we look at that, we have to specify [it is the proceeds] of the loan [which are] actually tax-free.”

Read the article at Forbes.

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  • The proceeds from a reverse mortgage are generally not taxable upon receipt. They may become taxable at termination if any portion of the unpaid principal balance is not paid in full by the borrower or heirs.

    Under federal income tax law and regulation, reverse mortgages are no different than any other non-recourse mortgage. If when the reverse mortgage is terminated, a portion of the Unpaid Principal Balance (UPB) is not paid off by the borrower or heir, that unpaid amount is added to the cash proceeds from the title of the home in determining gain or loss. So say the home is worth $275,000, the Unpaid Principal Balance is $412,000, and the borrower has not paid $137,000 of the amount due and payable. So for purposes of gain or loss, the gross proceeds are $275,000 but the adjusted sales price is $412,000 for purposes of determining income tax federal gain or loss.

    Let us say that the home was acquired 30 years ago for $110,000 and the homeowner remodeled the kitchen for $35,000 and also added $15,000 in upgrades and amenities. So the adjusted basis of the home for income tax purposes is $160,000 for a gain of $252,000. The widow who owns the home became a widow 10 years ago. Since she has lived in the home as her principal residence for 30 years, up to $250,000 of that gain is excluded which means only $2,000 of the gain will be included in total income as long-term capital gains for federal income tax purposes. The treatment of nonrecourse debt forgiven in the disposition (i.e. through sale, deed-in-lieu- of-foreclosure, short sale, foreclosure, etc.) of the collateral for a nonrecourse mortgage (or other debt) as described in 26 CFR Section 1.1001-2.

    Reverse mortgage educators generally know reverse mortgages (with some glaring exceptions) but they have little expertise in federal or state income tax matters. Practicing outside of one’s expertise is not only a dangerous thing but it can be detrimental to those who follow such advice. Reverse mortgage educators feign dismay when the mail carrier provides advice on reverse mortgages. These same reverse mortgage educators should apply that same standard to their own intrusion into areas where they lack expertise.

    What is glaring is that there is no mention of the deduction of interest and what those rules are.

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