Do You Pay Tax on Equity Release? An Explanation

Equity release allows homeowners to access the wealth stored in their property without selling it. This financial option, often considered by older adults, involves leveraging a home’s value to receive funds, either as a lump sum, regular payments, or a line of credit. Understanding the tax implications of these arrangements is important, as they can significantly impact an individual’s financial situation.

Tax Treatment of Equity Release Funds

Funds received through equity release, such as home equity loans, home equity lines of credit (HELOCs), or reverse mortgages, are generally not considered taxable income by the Internal Revenue Service (IRS). This is because these funds are treated as borrowed money, not earnings. For example, proceeds from a reverse mortgage are loan advances against the home’s equity and are not subject to income tax upon receipt. Money drawn from a home equity loan or HELOC is also a loan that must be repaid, not income.

This tax-free treatment applies to the principal amount borrowed. If the funds are used to pay off an existing mortgage, for home improvements, or for living expenses, the initial receipt itself does not create a taxable event. However, it is important to differentiate between the receipt of the loan funds and their subsequent use or retention, as these later actions can have other tax implications.

Interest Accrual and Tax Considerations

The interest component of equity release products, particularly reverse mortgages, operates differently than traditional loans. For reverse mortgages, interest typically accrues over time and is added to the total loan balance, meaning borrowers do not make regular monthly interest payments. This accrued interest is generally not tax-deductible until the loan is fully repaid, which usually occurs when the home is sold or the borrower no longer lives there. The IRS considers this interest deductible only when actually paid, and typically only if the loan proceeds were used for specific purposes, such as buying, building, or substantially improving the home.

For home equity loans and HELOCs, the deductibility of interest has specific conditions. Interest on these loans is generally deductible only if the borrowed funds are used to buy, build, or substantially improve the home that secures the loan. This means interest is not deductible if the funds are used for personal expenses like paying off credit card debt, college tuition, or vacations. There are also limits on the total mortgage debt, including home equity loans, for which interest can be deducted; this limit is generally $750,000 for loans taken out after December 15, 2017, and before 2026.

Federal Estate Tax Implications

Equity release can influence an individual’s federal estate tax liability. When a home equity loan, HELOC, or reverse mortgage is taken out, it increases the debt against the property, effectively reducing the net value of the estate. This reduction can potentially lower the federal estate tax payable upon the homeowner’s death. The federal estate tax applies only to estates exceeding a certain exemption limit, which for 2025 is $13.99 million per individual. Married couples can effectively pass on twice this amount without federal estate tax implications.

If the funds received from equity release are spent during the homeowner’s lifetime, they are no longer considered part of the estate and are not subject to federal estate tax. However, if a significant portion of the funds remains unspent and is held as an asset at the time of death, these retained funds would be included in the deceased’s estate for tax purposes. Some states may also impose their own estate or inheritance taxes, which can have different exemption thresholds and rules.

Effect on Means-Tested Benefits

While equity release funds are typically not treated as income for tax purposes, receiving a large lump sum can impact eligibility for certain government benefits that are means-tested. These programs base eligibility on an individual’s income and financial assets. Examples include Medicaid and Supplemental Security Income (SSI).

If the equity release funds cause a person’s countable assets to exceed program thresholds, they may lose eligibility or see a reduction in their benefit amount. For instance, if a lump sum from a reverse mortgage or home equity loan is not spent within the month it is received, it can count as an asset. Individuals considering equity release should evaluate how the funds might affect their eligibility for needs-based assistance.