Deducting Reverse Mortgage Interest on Your Tax Return
Key Takeaways
- Interest on a reverse mortgage is only deductible when it is actually paid.
- Since reverse mortgages don't require monthly payments, you usually can't deduct interest annually.
- The deduction is typically claimed as a lump sum when the loan is finally paid off.
For decades, homeowners with traditional mortgages have enjoyed the tax benefit of deducting their mortgage interest on Schedule A of their federal tax returns.
Because reverse mortgages charge interest, many seniors wonder if they can claim this same lucrative deduction. The answer is yes, but the timing is completely different.
The Rule of "Actual Payment"
The IRS rule for deducting mortgage interest is simple: You can only deduct interest in the year it is actually paid to the lender.
With a traditional mortgage, you make a payment every month. A portion of that payment goes toward interest. At the end of the year, the bank sends you a Form 1098 detailing exactly how much interest you paid, which you then deduct.
With a Home Equity Conversion Mortgage (HECM), you do not make monthly payments. The interest accrues and is simply added to your loan balance. Because you haven't actually handed any cash to the lender, you cannot deduct the accrued interest on your annual tax return.
When Can You Deduct It?
You (or your estate) can only claim the reverse mortgage interest deduction in the year the loan is actually paid off. This usually happens in three scenarios:
- You Sell the Home: When you sell the home and the proceeds are used to pay off the reverse mortgage balance, the massive amount of accrued interest is officially "paid." You can deduct it on that year's tax return.
- You Refinance: If you refinance the reverse mortgage, the old loan is paid off, triggering the deduction.
- You Pass Away: If your heirs sell the home to pay off the loan, the accrued interest is paid. Your estate can often claim this deduction on the final estate tax return, which can be highly beneficial if the estate faces tax liabilities.
Voluntary Payments
There is one exception. A reverse mortgage allows you to make voluntary payments at any time without penalty. If you choose to write a check to your lender for $5,000 in December, the lender applies it to your accrued interest first. You can then deduct that $5,000 on that year's tax return.
Consult a CPA before attempting to use voluntary reverse mortgage payments as a tax strategy.