How Is Money Received from a Reverse Mortgage Taxed?

In the United States, the funds received from a reverse mortgage are not considered taxable income. Understanding the tax implications of a reverse mortgage is crucial for borrowers considering this type of loan. Here’s an in-depth look into how these proceeds are treated from a tax perspective.

Is Money Received from a Reverse Mortgage Taxable?

In the USA, loan proceeds are not considered taxable income. The money received from a reverse mortgage is just another form of loan proceeds. This means that you do not have to pay income tax on the funds you receive. Whether you take out a lump sum, a line of credit, or monthly payments, none of these payments are taxed.

Tax Implications for the Borrower

From the borrower's perspective, the equity that you receive from a reverse mortgage is not taxed. If you have taken out a forward mortgage, which involves monthly payments and you refinance to extract equity, that equity is not taxed either. This is because these funds are not treated as income for tax purposes.

Even if the borrowing against the collateral value of the house is structured as ongoing payments to the borrower that resemble income, these payments are not considered income either from a taxation standpoint or an accounting standpoint. Essentially, they are just a series of consumer loans. This means that the proceeds from a reverse mortgage are not subject to any federal, state, or local income taxes.

For the Lender - Deferred Interest

It's important to note that from the lender's perspective, the deferred interest is considered taxable income. When you take out a reverse mortgage, the interest on the loan is deferred until the loan is paid off, such as when the home is sold or the borrower moves into a permanent care facility. This deferred interest accrues until the loan is repaid and is subject to income tax for the borrower at that time.

Here's a detailed breakdown of how this works:

Initial Withdrawal: The money received from the initial withdrawal is not taxed. Accrued Interest: Any accumulated interest that has not yet been repaid also is not taxed until the loan is repaid. Sale of the Property: When the property is sold, any remaining loan balance, including the deferred interest, must be repaid. The borrower may owe taxes on this balance, depending on how it is structured and the specific tax laws applicable at that time. Inheritance Taxes: If the homeowner dies while still owing money on a reverse mortgage, the remaining balance is subject to inheritance taxes if the home is part of the deceased's estate.

FAQs

Q: Is the interest from a reverse mortgage considered taxable income?
A: The interest from a reverse mortgage is not considered taxable income until the loan is repaid. At that time, the borrower may have to pay taxes on the accrued interest. Q: Can a reverse mortgage be structured as a tax-free option?
A: Yes, the funds received from a reverse mortgage are typically structured as a tax-free option. As long as the payments are not considered taxable income, the loan itself can be structured in a way that minimizes any potential tax burden. Q: Are there any exceptions to the tax-free nature of reverse mortgage proceeds?
A: Yes, there are certain exceptions. When the home is sold, the remaining loan balance must be repaid, and the borrower may owe taxes on this balance. Additionally, unpaid deferred interest is subject to income tax when the loan is repaid.

Conclusion

Understanding the tax implications of a reverse mortgage is crucial for any borrower considering this loan option. The funds received from a reverse mortgage are not considered taxable income, providing a tax-free flow of funds to the borrower. However, it's important to be aware of the deferred interest and its impact on potential future tax liabilities. Seeking advice from a tax professional can help ensure that you fully understand these complexities.