Does Equity Release Affect Inheritance Tax?

As individuals approach retirement, homeowners often consider various financial tools to manage their assets and ensure long-term security. Two concepts that frequently arise in these discussions are accessing home equity and planning for wealth transfer to heirs. Understanding how these two financial areas intersect is important for individuals seeking to optimize their financial position. This article explores the very relationship between utilizing home equity and the implications for estate taxation.

What is a Reverse Mortgage?

A reverse mortgage allows homeowners to convert a portion of their home equity into cash. This financial product is commonly known as a reverse mortgage in the United States, serving a similar purpose to what is termed “equity release” in other regions. It enables individuals, typically those aged 62 or older, to access funds from their property without selling their home or making monthly mortgage payments. The homeowner retains the title to their property throughout the loan’s term. This can provide financial flexibility for various needs, such as covering living expenses or healthcare costs.

Funds can be received in various ways, including a lump sum, monthly payments, or a line of credit. Unlike a traditional mortgage where the borrower makes payments to the lender, with a reverse mortgage, the lender makes payments to the borrower, or the loan balance grows over time. The loan, with accrued interest and fees, becomes due when the last borrower permanently moves out, sells the home, or passes away. Homeowners remain responsible for property taxes, homeowners insurance, and home maintenance.

What is Estate Tax?

Estate tax is a tax levied on the fair market value of an individual’s property and assets at the time of their death. This tax applies to the deceased person’s entire estate, including real estate, bank accounts, investments, and other possessions. The purpose of this tax is to collect revenue on wealth transferred from a deceased individual to their beneficiaries or heirs. The federal government imposes an estate tax, and a few states also impose their own estate or inheritance taxes.

For federal estate tax purposes, a significant exemption amount is in place, meaning only estates exceeding this threshold are subject to the tax. For individuals dying in 2025, the federal estate tax exemption is $13.99 million. This amount is adjusted annually for inflation, and for 2026, it is set to increase to $15 million per person. The tax applies only to the portion of the estate’s value that exceeds this exemption.

How a Reverse Mortgage Can Reduce Your Estate

A reverse mortgage can directly impact the net value of an estate for estate tax calculations. When a homeowner takes out a reverse mortgage, they convert a portion of their home equity into liquid funds. This action effectively reduces the amount of equity remaining in the home, which is a significant asset within the overall estate. As funds are disbursed to the homeowner, the outstanding loan balance on the property increases over time due to accrued interest and fees.

Upon the homeowner’s death, the reverse mortgage loan becomes due. The outstanding balance is typically repaid from the home’s sale or by heirs who choose to keep the property. The amount owed directly reduces the home’s net value within the estate. For example, if a home is valued at $500,000 and has an outstanding reverse mortgage balance of $200,000, then only the remaining $300,000 of equity contributes to the taxable estate from that asset. This reduction can potentially lower the overall estate value, possibly bringing it below federal or state estate tax exemption thresholds.

Funds received from a reverse mortgage are generally tax-free as they are considered loan proceeds, not income. If these funds are spent during the homeowner’s lifetime, they are no longer part of the estate at death. If retained as cash or other assets, their impact depends on how much remains and the overall estate size relative to exemption amounts. Therefore, a reverse mortgage can serve as a strategy to reduce the value of the home, often the most substantial asset, within an estate, potentially mitigating estate tax liability.

Different Reverse Mortgage Options and Their Estate Tax Impact

The most prevalent type of reverse mortgage in the United States is the Home Equity Conversion Mortgage (HECM). HECMs are federally insured by the Federal Housing Administration (FHA). With a HECM, the homeowner takes out a loan against the equity in their home, and the loan balance increases over time as interest accrues and advances are taken.

A key feature of HECMs is their non-recourse nature. This means heirs are generally not responsible for repaying any loan amount that exceeds the home’s value when the loan becomes due. This protection ensures heirs will not owe more than the home is worth, even if the market value declines.

Other reverse mortgage options include proprietary reverse mortgages from private lenders and single-purpose reverse mortgages from state and local government agencies or non-profit organizations. Proprietary reverse mortgages are typically for higher-valued homes and may offer larger loan amounts. Single-purpose reverse mortgages are often limited to specific uses, such as home repairs or property tax payments, and are generally less expensive. Regardless of the specific type, the outstanding loan balance reduces the net value of the home within the estate for estate tax purposes.