Understanding Reverse Mortgages: A Tax-Saving Solution for Older Homeowners

Are you an older homeowner with a house that has significantly appreciated in value? If you also find yourself needing additional income, a reverse mortgage might be a viable solution with a potential tax-saving bonus.

Reverse Mortgage Basics

A reverse mortgage allows you to convert part of your home’s equity into cash without having to sell your house. Unlike a traditional mortgage where you make payments to the lender, with a reverse mortgage, the lender makes payments to you. Over time, the mortgage principal increases, and interest accrues, adding to the loan balance. Typically, repayment is not required until you permanently move out of the home or pass away.

You can receive reverse mortgage proceeds in various forms:

• Lump Sum: A one-time payment.
• Installments: Regular payments over a period of time.
• Line of Credit: Withdrawals as needed.

This means you can stay in your home while converting its equity into cash, unlike selling your highly appreciated home which might require relocation and potentially trigger a significant tax bill.

Most reverse mortgages are Home Equity Conversion Mortgages (HECMs), which are insured by the federal government. To qualify, you must be at least 62 years old. For 2024, the maximum amount you can borrow with an HECM is $1,141,825, but the actual amount depends on your home’s value, your age, and any existing mortgage debt. Reverse mortgage interest rates can be fixed or variable, and they are generally slightly higher than regular home loan rates.

Basis Step-Up and Reverse Mortgage Benefits

Selling a highly appreciated home can trigger a taxable gain that exceeds the federal home sale gain exclusion ($250,000 for unmarried individuals and $500,000 for married couples filing jointly). The resulting tax bill can be substantial, particularly in states with personal income tax.

Reverse Mortgage Advantages FAQ:

• Is Reverse Mortgage Income Taxable?: By taking out a reverse mortgage instead of selling your home, you can avoid this tax bill. Therefore, reverse mortgage income is not taxable and is a good tax saving solution for older homeowners.
• Can a Reverse Mortgage Help You Access The Cash You Need?: Yes, reverse mortgages allow you to obtain the cash you need without selling your home.
• What is the benefit from Basis Step-Up?: Upon death, the federal income tax basis of an appreciated capital gain asset, including a personal residence, is stepped up to its fair market value (FMV).

How the Basis Step-Up Works:

The basis step-up rule means that if your heirs sell the home after your death, the taxable gain is minimized because the sales proceeds are offset by the stepped-up basis.

The Reverse Mortgage Angle:

Holding onto a highly appreciated residence until death can save significant taxes due to the basis step-up rule. A reverse mortgage allows you to access the equity in your home without needing to sell it. When you move out or pass away, the property can be sold, the reverse mortgage balance paid off, and any remaining proceeds can go to you or your estate. This way, you remain in your home and avoid a hefty tax bill.

Consider the Options

If you need cash, selling your highly appreciated home could result in a substantial tax bill and require you to relocate. In contrast, a reverse mortgage allows you to access the necessary funds while staying in your home. The costs are primarily the fees and interest charges, which may be significantly less than the taxes you could avoid by benefitting from the basis step-up rule.

We Can Help

If you’re considering a reverse mortgage, contact us to discuss how it can be a tax-smart solution for your financial needs. We can provide guidance tailored to your specific situation and help you make the most informed decision.