Is a Reverse Mortgage Considered Income?

A reverse mortgage allows homeowners aged 62 and older to access a portion of their home’s equity as cash. Unlike a traditional home loan where the borrower makes monthly payments to a lender, a reverse mortgage pays the borrower. The loan balance, which includes the funds received plus accrued interest and fees, does not have to be repaid until the homeowner sells the home, moves out, or passes away. Understanding how these funds are classified for tax and benefit eligibility purposes is a primary concern.

Tax Treatment of Reverse Mortgage Proceeds

The Internal Revenue Service (IRS) does not consider money received from a reverse mortgage to be taxable income. Instead, the payments are treated as loan proceeds because the funds represent a debt that must eventually be repaid. You are borrowing against your own equity, not earning new income.

This tax treatment is consistent regardless of how the funds are disbursed. Whether a borrower chooses to receive the money as a single lump sum, a series of fixed monthly payments, or a flexible line of credit to draw upon as needed, the funds are not reported as income on a federal tax return. This principle is similar to other forms of secured debt, such as a traditional mortgage or a home equity line of credit (HELOC).

Because the proceeds are classified as a loan and not income, they do not increase your taxable income or push you into a higher tax bracket. The borrower retains title to the home and remains responsible for paying property taxes and homeowners insurance.

Impact on Government Benefits

The classification of reverse mortgage funds as loan proceeds has a direct bearing on eligibility for government benefits, but the impact differs depending on the program. For entitlement programs like Social Security retirement benefits and Medicare, eligibility is not based on financial need. Since reverse mortgage payments are not considered income, they do not affect your qualification for these benefits.

The situation is different for means-tested programs such as Supplemental Security Income (SSI) and Medicaid, which have strict limits on both income and assets. While the funds from a reverse mortgage are not counted as income in the month they are received, any unspent money can be classified as a resource or asset. If these remaining funds, when added to other countable assets, exceed the program’s limit on the first day of the following month, eligibility can be jeopardized.

For example, SSI has resource limits of $2,000 for an individual and $3,000 for a couple. Receiving a large lump-sum payment and depositing it into a bank account could easily push a recipient over this threshold, leading to a suspension or termination of benefits. To avoid this, borrowers on these programs might consider structuring payments as a line of credit or monthly installments and spending the funds within the same calendar month they are received.

Tax Implications of Loan Repayment

Interest on a reverse mortgage accrues over time and is only deductible once it is actually paid. This payment typically occurs when the loan is settled through the sale of the home. According to IRS Publication 936, the interest is only deductible if the loan proceeds were used to buy, build, or substantially improve the home securing the loan.

When the home is sold to repay the loan, capital gains tax may apply. This tax is on the profit from the sale, not on the loan proceeds themselves. The gain is calculated as the difference between the home’s sale price and its basis, which is the original purchase price plus the cost of capital improvements. However, homeowners may be able to exclude up to $250,000 of this gain, or $500,000 for a married couple filing jointly, if they meet the ownership and use tests for a primary residence.

Most reverse mortgages insured by the Federal Housing Administration (FHA) are non-recourse loans. This feature means that the borrower or their estate will never owe more than the home’s appraised value at the time the loan is repaid. If the loan balance exceeds the home’s sale price, the FHA insurance covers the difference, and the forgiven portion of the debt is not considered taxable income for the borrower or their heirs.

Considerations for Heirs

When a homeowner with a reverse mortgage passes away, their heirs inherit the property along with the responsibility of settling the loan. The heirs are typically given a set period, often starting at six months, to decide how to proceed. Their primary options are to pay off the loan balance and keep the home, sell the property to satisfy the debt, or sign a deed in lieu of foreclosure to turn the home over to the lender.

A significant tax provision for heirs is the “stepped-up basis.” Under this rule, the property’s cost basis for tax purposes is adjusted to its fair market value at the date of the original owner’s death. This reduces or often eliminates the capital gains tax liability if the heirs sell the property. For instance, if a home was purchased for $50,000 but is worth $350,000 when inherited, the basis for the heirs becomes $350,000.

If the heirs sell the home shortly after inheriting it for a price close to its fair market value, there will be little to no capital gain to tax. The sale proceeds are first used to pay off the loan balance, and any remaining equity belongs to the heirs. Because of the non-recourse nature of most reverse mortgages, if the home sells for less than the loan balance, the heirs are not personally responsible for the shortfall.