Is Income From a Reverse Mortgage Taxable?

A reverse mortgage allows homeowners, typically those 62 or older, to convert a portion of their home equity into cash. This financial tool provides funds that can be received as a lump sum, a series of monthly payments, or a line of credit. Unlike a traditional mortgage where the homeowner makes payments to the lender, a reverse mortgage involves the lender making payments to the homeowner. The loan, along with accrued interest, generally becomes due when the borrower sells the home, moves out, or passes away.

Tax Treatment of Reverse Mortgage Payments

The money a homeowner receives from a reverse mortgage is not considered taxable income. The Internal Revenue Service (IRS) views these payments as loan proceeds, not as earnings or wages. Because the funds are borrowed money that must eventually be repaid, they do not fall into the category of income that needs to be reported on a tax return.

This treatment is similar to other forms of secured debt, such as a home equity loan or a home equity line of credit (HELOC). When you borrow against your home’s value, you are accessing your equity in the form of a loan, not generating new income. Consequently, these advances do not increase your adjusted gross income for the year. You retain the title to your home throughout the life of the loan.

Deductibility of Reverse Mortgage Interest

The rules for deducting interest on a reverse mortgage differ from a traditional mortgage. For a reverse mortgage, interest accrues over the life of the loan and is added to the principal balance. This accumulated interest is not deductible on an annual basis because it has not yet been paid.

The deduction for accrued interest becomes available when the interest is actually paid. This occurs when the loan is paid off, which usually happens when the home is sold or the borrower’s estate settles the loan. At that point, the total interest paid may be deductible, subject to the rules for home mortgage interest in IRS Publication 936. For the interest to be deductible, the loan proceeds must have been used to buy, build, or substantially improve the home securing the loan.

Tax Implications When the Loan is Repaid

When a reverse mortgage is repaid, typically through the sale of the home, the primary tax consideration is capital gains tax. The potential tax liability arises from the profit realized on the sale of the property. This gain is calculated by subtracting the home’s adjusted basis—its original purchase price plus the cost of any capital improvements—from the final sale price.

If the sale results in a gain, the homeowner may be able to exclude a significant portion of it from their income. A single filer can exclude up to $250,000 of capital gains, and married couples filing jointly can exclude up to $500,000. This exclusion applies if the homeowner has owned and used the property as their main residence for at least two of the five years preceding the sale. Reverse mortgages are non-recourse loans, meaning if the home sells for less than the loan balance, the lender cannot pursue the borrower or their estate for the difference, and this forgiven debt is not treated as taxable income.

Impact on Government Benefits

While reverse mortgage proceeds are not taxable income, they can affect eligibility for certain needs-based government benefits. Programs like Social Security and Medicare are not affected because they are entitlement programs not based on financial resources. However, programs like Supplemental Security Income (SSI) and Medicaid have strict limits on both income and assets.

The funds received from a reverse mortgage are not counted as income for these programs. They are, however, considered a liquid asset if they are not spent within the calendar month they are received. If holding onto these funds pushes a recipient’s total countable assets over the program’s limit, such as $2,000 for an individual for SSI, it could result in a loss of eligibility. Planning, such as receiving funds in smaller monthly installments rather than a lump sum, can help manage asset levels and maintain eligibility.