A reverse mortgage is available to an individual age 62 and older. The reverse mortgage must be secured by a first trust deed. Thus, any existing loans have to be paid off with separate funds or with the proceeds from the reverse mortgage. The amount that can be borrowed is based upon age. The older the borrower, the greater amount that can be borrowed and the lower the interest rate. The rules are complicated and depend upon the type of current debt owed by the potential borrower. When a reverse mortgage is paid off, there is accrued interest to be paid along with the loan balance payoff and some of that interest may be deductible.

There are a number of factors to consider in determining whether accrued reverse mortgage interest is deductible and by whom. Equity debt interest is not deductible with year 2018. However, if the reverse mortgage refinanced an existing home acquisition debt then when the reverse mortgage loan is paid off a prorated portion of the accrued interest will be deductible home acquisition debt interest.

We generally think of a reverse mortgage as providing for the living expenses of the taxpayers. As we have learned in taxes, always expect the unexpected. The tracing rules apply as with any debt and character of the debt is determined by the use of the funds. Making the assumption that the use is all personal and the interest non-deductible may not be correct. Who knows, the taxpayer may be using the proceeds for his business or investment.

The deductibility of reverse mortgage interest follows the same limits as conventional loans except the deduction is limited to what would have been deductible each year if the borrower had paid it and accrues until the loan is paid off, at which time it is deductible.

If the debtor pays off the reverse mortgage, the deductible accrued interest may be limited. In the case where none of the mortgage is considered acquisition debt, the interest on debt up to the $100,000 limit would be deductible as equity interest if paid before 2018. After 2017 equity interest is no longer deductible. The deductibility of any excess debt would be based upon the interest tracing rules (Temp Reg. Sec 1.163-8T). Generally, reverse mortgage payments are used for personal expenses of the borrower, and therefore the interest on the excess debt is generally not deductible.

When a reverse mortgage is paid off after the debtor’s death, the interest on the reverse mortgage is allowable as a deduction in respect of a decedent (DRD), deductible under IRC §691(b) either by the estate or by the beneficiary. If the estate is not liable for the obligation, then the person who inherits the property from the estate (subject to the obligation) is entitled to the deduction (IRC §691(b)(1)(B)). In either case the interest deduction is limited to what the decedent could have deducted, so the interest limitations apply and equity interest paid after 2017 and through 2025 would not be included. 

Even though the interest accrued on the reverse mortgage before the borrower’s death and was paid after the borrower’s death, it qualifies as a deduction in respect of the decedent (DRD). Therefore, the estate can deduct the interest on its income tax return (Form 1041) as a DRD (Sec 691(b)(1)(B)). However the amount deductible by the estate is limited to the interest that would have been deductible in the year to which it was attributable based upon the character of the debt (Sec 163(b)(2)). And if the payoff occurs after 2017, any portion of the accrued interest that would have been equity debt isn’t deductible.

Even though the interest accrued on the reverse mortgage before the borrower’s death and was paid after the borrower’s death, it qualifies as DRD (Sec 691(b)(1)(B)). Therefore, the beneficiary, if itemizing deductions, may deduct the interest on his or her 1040 income tax return as a DRD. However, the amount deductible by the beneficiary is limited to the interest that would have been deductible in the year to which it was attributable based upon the character of the debt (Sec 163(b)(2)) and the post-2017 rule that no interest is deductible on equity debt applies.

A beneficiary who inherits a home (subject to a reverse mortgage) is required to either sell the home to satisfy the reverse mortgage debt or pay it off by some other means. If the beneficiary pays off the reverse mortgage by obtaining a new loan, to the extent the new loan is used to pay off the reverse mortgage, it would have the following treatment: