LEARNING CENTER
Key Insights into Reverse Mortgages for Homeowners
As a seasoned Certified Public Accountant, Hope St. Clair, CPA, at Cherokee CPA, provides expert guidance to small business owners navigating complex financial landscapes. One topic that often arises is reverse mortgages—a financial product gaining traction among homeowners aged 62 and above. Unlike traditional mortgages where homeowners repay lenders, reverse mortgages enable homeowners to receive payments from lenders, either as a lump sum, scheduled installments, or a flexible line of credit. This innovative approach can significantly impact tax strategies related to home equity.
Reverse mortgages require a first trust deed, with existing loans needing settlement through alternate finances or reverse mortgage proceeds. The borrowing potential is contingent upon the borrower's age—the older the borrower, the higher the borrowable amount, and the more favorable the interest rates. Understanding these complexities is crucial, as they interplay with existing debt structures.
One must not overlook the tax implications accompanying reverse mortgages. Though proceeds from these loans—whether in lump sums, credit lines, or monthly payments—are deemed non-taxable by the IRS as loan proceeds, they do possess significant tax planning considerations. These proceeds do not influence Social Security, Medicare benefits, or other income-based tax provisions.
Limited Interest Deduction
Interest is Deductible Only When Paid: Reverse mortgage interest deductions diverge from traditional approaches, becoming applicable only once the loan reaches full settlement—typically during a property sale or when the remaining borrower dies.
Form 1098: Upon settling the mortgage, a Form 1098 is issued by the lender, outlining interest payments.
Loan Purpose Limits Deduction: Deductions pertain to loans destined to “buy, build, or improve” the residence under IRC Section 163(h)(3). Most reverse mortgage funds utilized for general spending do not qualify for deductions, even upon repayment.
Accrued Reverse Mortgage Interest: Determining deductible accrued interest hinges on several criteria, particularly if equity debt interest intersects with home acquisition debt refinancing.
Who Claims the Deductible Accrued Interest: Parties repaying the loan may claim interest deductions, bound by stipulations regarding equity interest. Borrowers, estates, or heirs, based on the situation, may qualify for deductions.
Deductibility Limitations
Loan Balance Caps: Even if improvements are covered, IRS mandates restrict home mortgage interest deductions based on total debt, capped at $750k post-December 15, 2017, and $1 million prior.
Use of Funds Documentation: Precise records—receipts and invoices—are vital to justify deductions, authenticating reverse mortgage funds’ home improvement usage.
Potential Impact on Means-tested Benefits
Risk to Medicaid and SSI: Reverse mortgage proceeds, classified as assets, potentially affect eligibility for means-tested programs like Medicaid or SSI if retained unspent. Timely expenditure within the month is advisable to retain benefits.
Borrower’s Ongoing Responsibilities
Property Taxes and Insurance: Borrowers must ensure payment of property taxes, homeowner’s insurance, and other expenses to maintain home equity. Defaults can lead to foreclosure risks.
Financial Assessment: Prospective borrowers undergo assessments, determining their capacity to manage ongoing expenses. A portion of loan proceeds may be reserved in LESA accounts for recurrent bills in case of financial instability.
Considerations for Heirs
Limited Liability: FHA-insured HECMs guarantee non-recourse loans, safeguarding heirs from liabilities exceeding the home’s worth.
95% Rule: Offers heirs the choice to purchase the home at 95% of the appraised value or the loan balance, fostering financial security against excessive debt.
Capital Gains Tax: Standard capital gains tax rules apply to homes sold post-reverse mortgage, with a "stepped-up" basis aiding heirs in mitigating taxes.
Drawbacks of Reverse Mortgages
Despite offering cash-flow flexibility, reverse mortgages can escalate loan balances through interest accumulation, reducing equity available to both borrowers and heirs. Joint obligations covering taxes, insurance, and maintenance pose consistent challenges that can lead to foreclosure.
Notably, reverse mortgages often levy considerable fees and closing costs compared to traditional loans. Consequently, they may not suit those considering imminent relocation. Engage with Hope St. Clair, CPA, at Cherokee CPA, trained to provide strategic tax and accounting guidance for discerning individuals and families.
For further inquiries and personalized assistance, reach out to Hope's office at Cherokee CPA.
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