Understanding HECM Tax Deductions

The regular rules for how real estate tax deduction are taken are different in the case of reverse mortgages. It’s important to understand the distinction in order to ensure that you’re planning ahead in the most optimal way. In his latest Nerds Eye View column entitled The Taxation Of Reverse Mortgage Loan Proceeds And Interest Payments, blogger, tax specialist and financial planner Michael Kitces explains the various tax deductions that may apply to reverse mortgages.

The common assumption is that the interest paid over the life of the loan can only be deducted when a reverse mortgage is finally paid off. However, Kitces offers scenarios whereby mortgage insurance premiums and real estate taxes may also be deductible.

Reverse Mortgage Loans Are Non-Taxable
Typically, one of the benefits of a reverse mortgage is that it is tax-free. Of course, that is because it is a loan made against your assets, and that means that no money is being generated in the process. Kitces points out something else that is essential for seniors to know. If you are retired, your reverse mortgage won’t impact your other tax issues like taxation on social security payments or charges for Medicaid that are based on your income.

Can You Deduct Reverse Mortgage Interest?
Another important thing to note is that if your interest for your reverse mortgage accrues each year and you don’t pay it, you cannot deduct it in the traditional way in which you would deduct mortgage interest. Similarly mortgage insurance premiums can only be deducted if they are paid in the previous year. In the case of a no-payment reverse mortgage, as the term itself suggests, you have not actually paid.

The good news is that once you do repay your loan in full, at that point you will have the opportunity to deduct interest. One issue Kitces brings up that is often ignored applies to seniors who are not currently working. Often these individuals aren’t bringing in enough income to take a deduction. This can present a problem because there needs to be enough income to be offset. Of course, the deductions can grow to be quite large by the time they are paid off.

Kitces wisely suggests is that the owner needs to plan ahead how he or she will create taxable income in the year that the reverse mortgage will be repaid. He has some suggestions how to accomplish this goal. These suggestions include taking a IRA distribution or a partial Roth conversation. Another option is, of course, for the owner to generate enough income from other sources so that the deduction can be offset. In some cases, the property may have appreciated generating a capital gain. These excess gains would also be counted as income.

What if the Owner Passes Away?
In some cases, the reverse mortgage is paid off because the owner has passed away. If that is the case, it turns into an issue for the heirs of the owner. There is the chance that the beneficiary also won’t have enough income to offset either. Property owners should think ahead to who will inherit the property and whether or not that person will have sufficient income to absorb the deduction.

This is just a quick overview of what is discussed in The Taxation Of Reverse Mortgage Loan Proceeds And Interest Payments. I highly recommend that you check out this valuable article yourself. In the end, it truly is all about proper planning and thinking ahead, and that’s why I heavily emphasize that point to all of my clients.