Is Equity Release Tax Free? The Tax Implications

Equity release allows homeowners to convert a portion of their home equity into cash, often through a reverse mortgage in the United States. This financial tool enables individuals, typically seniors, to access their home’s value without selling or making monthly mortgage payments. This article clarifies the tax implications of equity release funds.

Income and Capital Gains Tax

Funds received through equity release are generally not considered taxable income by the Internal Revenue Service (IRS). The money is treated as loan proceeds, similar to a traditional mortgage, rather than earnings or a capital gain. These funds are typically exempt from federal income tax, providing a non-taxable cash source. They do not affect eligibility for non-means-tested benefits like Social Security or Medicare.

Receipt of these funds does not trigger a capital gains tax event. Capital gains tax applies when an asset, like a home, is sold for profit. With a reverse mortgage, the homeowner retains property ownership, and the transaction is a loan against the home’s equity, not a sale.

Homeowners enjoy a significant capital gains exclusion when their primary residence is eventually sold. Individuals can exclude up to $250,000 of capital gain, and married couples filing jointly can exclude up to $500,000, provided they meet ownership and use tests. This exclusion applies when the home is sold by the homeowner or their heirs, not when reverse mortgage funds are initially received.

Estate Tax Implications

Equity release can influence a homeowner’s estate value for federal estate tax purposes. When a reverse mortgage is taken out, the outstanding loan balance reduces the net equity in the home. Upon the homeowner’s death, this loan must be repaid, usually from the home’s sale or other estate assets.

This reduction in home equity lowers the overall taxable estate. The federal estate tax exemption amount is set at $13.99 million per individual in 2025, projected to increase to $15 million in 2026. Only very large estates incur federal estate tax.

Heirs inherit the property subject to the reverse mortgage lien. Reverse mortgages are non-recourse loans, meaning heirs are not personally responsible for any loan balance exceeding the home’s value if the home sells for less than the loan amount.

Impact on Means-Tested Benefits

While equity release funds are not taxable income, receiving a substantial lump sum can impact eligibility for government benefits. Many public assistance programs are “means-tested,” meaning eligibility depends on an individual’s income and financial assets. Holding a significant amount of cash from a reverse mortgage above specific thresholds can reduce or even eliminate eligibility for these benefits.

Programs like Medicaid and Supplemental Security Income (SSI) have strict asset limits. The asset limit for SSI is generally $2,000 for an individual and $3,000 for a couple, excluding the primary residence and one vehicle. Exceeding these limits, even with non-taxable reverse mortgage proceeds, can result in a suspension or termination of benefits until assets fall below the threshold.

Homeowners should understand how equity release proceeds might affect their current or future eligibility for such benefits. Careful financial planning is necessary to avoid unintended consequences, including structuring fund receipt or spending down assets to remain within benefit limits. Consulting with a financial advisor or benefits specialist can help navigate these complexities.