The Tax Implications of Reverse Mortgages

A reverse mortgage is a loan, not income, to the IRS

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A reverse mortgage is a type of home equity loan for older homeowners.You’re given cash in exchange for signing over the equity in your home, although you continue to hold title to the property. Interest accrues on the loan proceeds until you vacate the home, either by selling it, moving elsewhere, or in the event of your death. The loan then comes due. You don’t have to make any payments on it until that time.

The money isn't subject to income tax because it's a loan advance, not income. The lender will eventually get the money back. But there can be some other tax implications when obtaining a reverse mortgage.

Key Takeaways

  • A reverse mortgage is the opposite of a regular mortgage; the lender pays you every month instead of you paying the lender.
  • A lender will pay you cash equal to the equity you have in your home, but this means signing over that equity as collateral.
  • The loan proceeds aren’t income and they aren’t subject to income tax, although other types of taxes can come due.
  • Reverse mortgage proceeds are considered an asset for Medicaid purposes and could potentially disqualify you for benefits if you don’t spend the money in the month you receive it.

Reverse Mortgage Income Isn’t Taxed

You can take payment from a reverse mortgage in a few ways: in a lump sum, in incremental payments, or in combination. However you choose to take it, the money isn’t taxable because it’s not income, as mentioned. It’s the equity in your home converted to cash. The IRS calls the money “loan proceeds.”

How Reverse Mortgages Affect Government Benefits

These mortgages are only available to homeowners who are age 62 or older. The fact that the money is not considered income by the IRS can play a part if you’re receiving certain government benefits, as many seniors do.

As non-income, the loan proceeds generally won’t affect your Medicare or Social Security benefits because these programs aren't needs-based. You can take monthly reverse mortgage payments to bolster your Social Security payments and cover your budget. 

You paid into Medicare and Social Security throughout your working life, and you’re entitled to have some of that money back when you retire.

But Medicaid can be a different story because this program is “means-tested,” and it has more than one qualifying tier. One test measures your income, and another is based on the value of your financial resources. Again, the mortgage proceeds aren’t considered income, so you’ll avoid this requirement. But any reverse mortgage proceeds you have sitting in a bank account can disqualify you.

You’re permitted only $2,000 in countable assets if you're single, although some states allow for more. You could be eligible for up to $4,000 if you're married and both you and your spouse are applying. You would have to spend down any money over this amount in the month you receive it to qualify for Medicaid.

How To Deduct Reverse Mortgage Interest

As for the interest accruing on your loan, mortgage interest is tax-deductible; reverse mortgage interest can qualify, but there's a catch: You can't claim the deduction until the loan is paid off for whatever reason, and you might miss out on the deduction entirely, depending on how you spend the reverse mortgage proceeds.

Interest Must Be Paid

Remember, interest is accruing monthly on your reverse mortgage, but you’re not making any mortgage payments toward it. An IRS rule for claiming the mortgage interest deduction is that the interest has to have been paid to qualify. You can’t deduct accruing interest that you still owe. Therefore, your interest would not be deductible until you pay off the reverse mortgage loan.

You can deduct the interest portion of any payments you voluntarily elect to make before you vacate the home, even if you don’t pay off the reverse mortgage in full.

How You Spend the Money

How you spend your reverse-mortgage proceeds can affect deductibility of the interest as well. The IRS limits this deduction to loans where the money is used to “buy, build, or substantially improve” your home. You’d be ineligible for a deduction if you use the money to cover day-to-day expenses or to take that cruise you've been waiting for all your life, because a reverse mortgage is considered to be a home equity loan. It's not a traditional mortgage.

You Must Itemize Your Deductions

The mortgage interest deduction is an itemized deduction. You must itemize on Schedule A and submit the schedule with your Form 1040 tax return when you file. You can’t claim the standard deduction for your filing status if you elect to itemize, so this could mean paying tax on more income than you have to if the total of all your itemized deductions doesn’t exceed the standard deduction you’re entitled to for the year.

You can claim home mortgage interest on Line 8a or Line 8b of the 2021 Schedule A if you do decide that itemizing is in your best interest and if you qualify.

Other Taxable Situations With Reverse Mortgages

Taking out a reverse mortgage won’t spare you from paying property taxes. You still hold title to your home, so your county or municipal authority will continue to assess property taxes against you personally, not your lender. And not paying them could effectively result in foreclosure. Your lender may call the entire reverse mortgage balance due. Your home’s equity secures your loan, and your lender won’t want to lose that collateral to your local taxing authority if you don’t pay.

Capital gains tax may come due as well if you or your heirs should sell the home to pay off the mortgage. You could owe capital gains tax on the difference between what you initially paid for and invested into the property and the amount of the sale. But that amount would have to be rather significant before a capital gains tax kicks in. The IRS offers a home-sales exclusion if you owned and used your home as your primary residence for at least two of the last five years. You can realize up to $250,000 in gains as of 2022 without paying a tax if you’re single, or $500,000 if you’re married and file a joint tax return with your spouse.

Frequently Asked Questions (FAQs)

How do reverse mortgages work after the death of the homeowner?

A reverse mortgage must be repaid when the owner dies. The estate would typically sell the home to pay off the loan at that point. An inheriting heir might take out a traditional mortgage to buy it from the estate and pay off the reverse mortgage, or they could pay off the loan with their own funds.

What happens if you don’t pay your property tax when you have a reverse mortgage?

Property taxes remain an ongoing responsibility after you take out a reverse mortgage. Your reverse mortgage lender can call the loan due if you don’t pay them.

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Article Sources

  1. LongTermCare.gov. “Reverse Mortgages.”

  2. IRS. “For Senior Taxpayers.”

  3. Federal Trade Commission. “Reverse Mortgages.”

  4. LongTermCare.gov. “Glossary (Countable Assets).”

  5. IRS. “Publication 936 (2021), Home Mortgage Interest Deduction.”

  6. IRS. “Topic No. 409 Capital Gains and Losses.”

  7. IRS. “Topic No. 701 Sale of Your Home.”