A reverse mortgage is a mortgage taken out by a homeowner age 62 or older and that requires no payment as long as the owner remains living in the house. Interest accrues on top of the principal and is fully repaid when the owner moves or dies. The reverse mortgage is usually treated like a home equity line by the IRS, which means that a taxpayer can claim mortgage interest to the extent it is actually paid, under the same rules that apply to home equity lines.
In the United States, the interest a homeowner pays on his mortgage is tax-deductible up to certain deduction limits. According to the IRS, the interest on mortgages up to $1 million taken out to buy, build or improve an owner-occupied residence is fully deductible. Interest on mortgages up to $100,000 taken out for other purposes, such as to fund a vacation or college education, is also deductible. Mortgage interest deductions are claimed as one type of itemized deduction. Prior to 2010 and proposed to return in 2013, the total value of all itemized deductions may be reduced for upper income earners.
Reverse Mortgage Rules
Usually, reverse mortgages are considered like home equity loans that are not taken out to buy, build or improve a home. Therefore, the maximum value of a reverse mortgage on which a taxpayer could claim a mortgage interest deduction is $100,000. The limit could be higher to the that extent the reverse mortgage funds were used on home improvements. There is also one type of reverse mortgage that allows a borrower to buy a home. The key to the mortgage interest deduction, however, is that it applies to interest paid in the tax year the deduction is claimed. No payments are required on a reverse mortgage. Borrowers are allowed to make interest and principal payments, however. Any interest payments that are made may be deducted in the same year. If a borrower moves from the house and fully repays the reverse mortgage, all the accrued interest may be taken in that year.
An Unlikely Deduction
Congress created the legal mechanisms for lenders to provide reverse mortgages in order to give seniors living on insufficient fixed incomes the ability to stay in their homes by taking out equity without having to pay it back until they moved or died. Seniors in this category generally do not have the means to make interest payments on a reverse mortgage nor the need to acquire deductions. A homeowner looking for tax deductions generates income. Such a homeowner would more likely be better suited to a home equity line than a reverse mortgage.
If It Makes Sense
Although many borrowers take a lump sum from a reverse mortgage, there is a line of credit option that allows a borrower to take out money periodically under an overall limit that can rise over time with the property value. A homeowner who is still working when he takes out a reverse mortgage line of credit could choose to make interest payments in order to claim the interest deduction in the loan's early years. This strategy would have the added benefit of maintaining the loan balance, as only the principal initially taken out -- leaving more available to withdraw in later years as the borrower's income decreases in retirement.
Mary Gallagher runs Mary Gallagher Planning (mgaplanning.com), an urban planning and consulting business in San Francisco. She is the former assistant planning director for San Francisco and planning director for San Mateo. Gallagher has been writing about real estate, development and land use for numerous websites since 1995. She holds a master's degree in historic preservation planning from Cornell University.