You can be forgiven for not knowing exactly how tax reform will affect reverse mortgages — after all, with the legislation itself passed hastily to capitalize on rare consensus among Congressional Republicans; accountants and other financial professionals will likely be busy sorting out the implications all the way through tax day and beyond.
For many homeowners, the disappearance of a tax deduction for home equity interest will have a significant impact on their annual tax bills, whether they have a forward mortgage or a HECM product. But as retirement blogger Tom Davison points out, not all interest is created equal.
Different types of mortgage debt
Let’s say you use a HECM for purchase to buy a new house. The interest that accrues on the mortgage counts as “acquisition debt,” meaning you can still deduct it from your taxes each year; this even applies if you used a forward mortgage to buy your house, then refinanced it into a reverse mortgage later.
But if you use the proceeds to support your retirement income, delay receiving Social Security payments, or cover increased health care costs, that counts as regular old home equity debt, which you can no longer deduct under the new rules.
The concept of “acquisition debt” can also extend to “substantially improving” a home, according to financial blogger Michael Kitces. He emphasizes that under the government’s definition, the type of loan doesn’t matter — it’s all about how you use it.
You can take out a traditional home equity line of credit (HELOC) to pay off credit card debt or supplement an investment portfolio, and it counts as non-deductible home equity debt. Or you can take out a HELOC to improve your home, and it counts as a deduction.
Additionally, even if you have the deductible kind of debt, the rules have tightened: Beginning December 15 the interest deduction is limited to $750,000 of debt, down from the previous cap of $1 million. Loans taken out before that date still retain the old limit, however.
Other reverse mortgage tax considerations
If you happen to live in certain parts of the country, the new tax plan could also affect one of the main ongoing costs of having a reverse mortgage: property tax payments. Homeowners in certain parts of California, New York State, and other jurisdictions with high property taxes have long enjoyed the benefit of writing off those local expenses from their federal returns.
But under the new tax plan, those deductions are capped at $10,000 a year — prompting some, such as residents of Long Island, N.Y., to line up at local tax offices last month and prepay their tax bills before the December 31 cutoff.
Of course, everyone’s tax picture is different, and if you have any questions about your particular situation, consult a certified public accountant before making any major financial moves that could affect your tax picture going forward. And of course, one of our knowledgeable reverse mortgage professionals can always help you navigate the process of taking out a reverse mortgage loan.