When you take out a reverse mortgage, you have several options for how to receive the proceeds: as a lump sum, a line of credit, a series of monthly payments or some combination of these.
You can even change your mind about how to receive the proceeds after you’ve started receiving them, as long as you still have enough home equity left to make the new choice work. For example, you may not be able to switch from a lump sum to another option if you’ve tapped most of your available equity.
Whichever way you choose to receive the proceeds from a reverse mortgage, you don’t have to pay any income tax on the money you receive.
The money received on a reverse mortgage isn’t taxable because while it might seem like income, the money you receive from a reverse mortgage is like the money you receive from a home equity loan or line of credit. You’re borrowing against the value of your home, not earning money from work or investments. And you’re eventually going to repay the money, either by selling the home when you’re still alive or by letting the bank sell it after you pass away. The IRS considers reverse mortgage proceeds to be loan proceeds, not income.
Tax deductions and reverse mortgages
The costs associated with a reverse mortgage might allow you to take some income tax deductions.
Property taxes are deductible if you itemize your deductions on Schedule A, though many seniors may not have enough deductions to make itemizing a better choice than taking the standard deduction. And if you pay off your reverse mortgage at some point — say, because you want to move — all the loan interest you pay to the lender at that point will be tax deductible if you itemize. In this case, you’re more likely to be able to itemize your deductions because you’ll be paying a large amount of interest in a lump sum. In the year you sell, you might then also be able to deduct your property taxes.
Seniors who choose to make payments on their reverse mortgage while still living in the home, which they might do so they can borrow more later and owe less interest, can also deduct interest in the year they pay it. Mortgage insurance premiums may be tax deductible as well if your adjusted gross income is less than $100,000.
While homeowner’s insurance is another cost associated with a reverse mortgage, it is not tax-deductible.
Capital gains taxes and reverse mortgages
You could owe taxes if you have a capital gain when you sell your home and pay off your reverse mortgage.
But the first $250,000 of home price appreciation isn’t taxable when you sell if you’re single, and the first $500,000 isn’t taxable when you sell if you’re married. That means if you bought your home for $150,000 and you sell it for $250,000, you won’t owe any capital gains tax because you’re only making $100,000 on the sale.
However, if you bought your home for $150,000 and you sell it for $500,000 and you’re single, you will owe capital gains tax on the amount of the gain above $250,000, which would be $100,000.
This capital gains tax exemption applies as long as the home has been your primary residence for two of the past five years before you sell it, though there are exceptions to the two-year rule if your move is related to a change in your health or employment. Also, home improvements increase your home’s cost basis, so if you’d made $100,000 in improvements on your $150,000 home, you wouldn’t owe any capital gains tax.
The bottom line
In sum, taking out a reverse mortgage is a major financial decision with important implications. But proceeds from a reverse mortgage is not taxable income.