How, When to Deduct a Reverse Mortgage

Question: “I have a reverse home mortgage. I understand that I cannot deduct interest on my home mortgage on my income tax return until I actually pay the interest. “
NOTE: Interest on a reverse mortgage is added to the loan balance each year but is not paid until the loan is repaid, usually at maturity or when the home is sold.

“I will be paying approximately $20,000 per year interest on paper until I sell my home. If I sell my home in five or 10 years, I will have paid $100,000 to $200,000 in interest.”

“I can’t believe the government will allow me to deduct that amount when I sell my home. Isn’t there some way I can deduct that interest while the interest is accumulating before I sell my home?”

Answer (from Kathleen Pender of the San Francisco Chronicle): Last question first: No, for practical purposes, you cannot deduct the interest each year while it is accumulating.

The only way to make this manuever work for mortgage loans is if you switched to the accrual method of accounting, which is not generally feasible for individual taxpayers, who typically use the cash method.

First question: The tax deduction could be limited, depending on how he used the money.

In general, you can deduct interest on up to $1 million in mortgage debt secured by your home as long as you use the money to buy, build or substantially improve that home.

If you borrow money secured by your home and use it to do anything other than to buy, build or improve your home (a home improvement loan would qualify) the loan is considered home equity debt.

In general, you can deduct interest only on up to $100,000 in home equity debt. The $100,000 limit applies to the amount of debt, not the interest payment on that debt.

Assuming you had no other debt on this house, if you took out a reverse mortgage for $250,000 and used $50,000 to remodel your kitchen and $200,000 to buy a car, take a trip and pay medical bills, you could deduct interest on only the first $150,000 worth of debt.

NOTE: Debt from home equity loans is not tax deductible under the alternative minimum tax. For more on reverse mortgages, visit your state’s department of real estate online.

SOURCE: San Francisco Chronicle