MarketWatch: How a Reverse Mortgage Can Interact with Taxes in Retirement

A new column at MarketWatch describes a scenario in which a reverse mortgage loan can provide benefit on taxes for senior homeowners in retirement. This is according to Bill Bischoff, a tax columnist for the online publication.

“Many seniors own hugely appreciated homes but are short of cash,” Bischoff writes. “Inflation makes things worse, and it doesn’t look like it’s going to get better anytime soon. An unwelcome side effect of owning a hugely appreciated home is the fact that selling the property to raise cash can trigger a taxable gain well in excess of the federal home sale gain exclusion break — up to $500,000 for joint-filing couples and up to $250,000 for unmarried individuals.”

Holding onto a residence that has appreciated in a pronounced way can be very beneficial to an older American’s tax bill due to the “basis step-up rule,” Bischoff writes. This rule involves the way that a home’s value interacts with the lives of the homeowners.

“If you’re married and your spouse predeceases you, the basis of the portion of the home owned by your departed mate, typically 50%, gets stepped up to fair market value (FMV),” Bischoff writes. “This usually removes half of the appreciation that has occurred over the years from the federal income tax rolls. So far, so good. If you then continue to own the home until you pass away, the basis of the part you own at that point, which will usually be 100%, gets stepped up to FMV as of the date of your death (or the alternate valuation date if applicable). So, your heirs can then sell the property and owe little or nothing to Uncle Sam.”

It’s less complex for an unmarried older homeowner, but for those who need access to additional cash immediately in order to make ends meet, this is where a reverse mortgage can come into play. A reverse mortgage does not become due-and-payable until the borrower passes away or leaves the home.

“At that time, the property can be sold, and the reverse mortgage balance paid off out of the sales proceeds,” Bischoff says. “Any remaining proceeds go to you or your estate. If your heirs would like to keep your home instead of selling it, they must pay it off with another source of funds. Alternatively, your heirs can pay off the reverse mortgage and keep the property along with the basis step-up. With a Home Equity Conversion Mortgage (HECM), your heirs will never have to pay more than the loan balance or 95% of the home’s appraised value, whichever is less.”

Other charges and fees will have to be addressed, including the mortgage insurance premium (MIP) and potentially a monthly servicing fee.

“[I]f you can get the cash you need by taking out a reverse mortgage, the only cost will be the fees and interest charges,” Bischoff writes. “If those fees and interest charges are a small fraction of the taxes that you could permanently avoid by continuing to own your home, the reverse mortgage strategy can make perfect sense.”

Read the column at MarketWatch. For more detailed information, visit the IRS’ dedicated page for reverse mortgages. Originators who receive questions concerning how a reverse mortgage will impact a specific borrower’s tax filings should always advise them to consult with a CPA or other certified tax professional.

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