7 Unexpected Ways a Reverse Mortgage Can Impact Your Taxes

One forgotten senior benefit may be the ability to take out a reverse mortgage. This is a special type of home loan for older homeowners, where you're able to access part of the equity in your home, which you can receive directly from your lender. The payments can come as a lump sum, monthly advance, line of credit, or a combination.

Unlike traditional mortgages, where you start making payments right away, reverse options don't require you to repay the money until after you no longer live in the house. However, these types of mortgages can come with special considerations that can make your taxes even more complicated. Take a look at these seven surprising ways a reverse mortgage might impact your taxes.

One of the basic things to know about taxes and a reverse mortgage is that payments aren't taxable. Reverse mortgage payments are considered loan proceeds, not income.

With a reverse mortgage setup, you repay the principal and then pay the lender interest as fees. As such, there's no taxable event involved in this.

You'll need to check the rules in your state to find out if your intangible taxes collected at settlement can be deducted, like in Florida, where borrowers can actually deduct the "intangible fee" associated with reverse mortgages.

How will you know? It may be best to look at your final settlement statement where it shows all fees. You may be able to claim some deductions related to this on Schedule A of Form 1040.

You want to keep several things in mind when it comes to interest and a reverse mortgage. First, your reverse mortgage may be due with interest when you move, sell the home, reach the end of the pre-selected period for the loan, or die. Second, interest accrued isn't deductible until you actually pay it.

Finally, and this may be among the more complicated aspects to understand, a deduction of interest may be limited because typically a reverse mortgage is limited by the home equity debt, which isn't deductible in many circumstances. A tax professional may be needed to help you sort through all this.

As we mentioned, a reverse mortgage isn't included in your taxable income. At the same time, it doesn't impact your other income taxes or things like Social Security, Medicare, or any other benefits tied to your income.

However, there may be some impact when it comes to Medicaid. Means-tested programs like Medicaid could include cash you have on hand from the reverse mortgage as part of your assets.

If your lender decides to forgive your loan, the IRS would then perhaps consider this a tax event. If that happens, the amount that is forgiven could be considered income in the year it's forgiven, and you may need to pay taxes on it.

It may seem obvious, but you will still owe property taxes with a reverse mortgage. Just like any mortgage, you maintain responsibility for property taxes, homeowners insurance, and home maintenance.

If you're someone with a lower income level or not-so-great credit, you may need loan insurance with a Life Expectancy Set-Aside (LESA). This is a balance that gets withheld from the total proceeds and used to pay for homeowners insurance real estate taxes during the life of your loan.

Capital gains taxes are usually owed on profits from selling an investment. If that investment is your primary residence, the IRS does have a special exclusion.

But with a reverse mortgage, capital gains are not as simple.

You as the borrower and your heirs can't owe more than the home is worth at the time of sale. When the mortgage becomes due, if your loan balance is greater than the sale price of the home, the difference is forgiven. That difference will, however, count as additional sale proceeds at tax time.

While a reverse mortgage may not be the best choice for every homeowner, it can be a tool some people turn to when they begin to prepare for retirement, especially when you consider the fact that a reverse mortgage may impact your taxes in some surprisingly beneficial ways.

But, before you decide to apply for one for yourself, you may want to talk to a tax or financial professional so you can learn more about what a reverse mortgage could mean in your unique financial situation.