Skip to content

Homeowner but Cash Loaner? The Reverse Mortgage Strategy

Are you an older taxpayer who owns a house that has appreciated in value but could use an additional source of income?  Taking out a reverse mortgage could be a solution to both problems that includes a tax-saving bonus.

The Basics of a Reverse Mortgage

A reverse mortgage operates exactly how it sounds. Instead of the borrower making payments to the lender to reduce the mortgage principal, the lender makes payments to the borrower which increases the mortgage principal over time. Interest accrues on the reverse mortgage and is added to the loan balance, but you typically don’t have to repay the balance until you permanently move out of the home or pass away.

You can receive reverse mortgage proceeds as a lump sum, as installments over a given period, or as line-of-credit withdrawals. The upside of a reverse mortgage is that you can stay in your home while converting some of the equity into much-needed cash. Otherwise, if you decide to sell your highly appreciated residence to raise money, it could involve relocating and a large tax bill.

Most reverse mortgages are called home equity conversion mortgages, or HECMs, which are insured by the federal government. The amount you can borrow depends on the value of your home, your age, and the amount of any existing mortgage debt against your property up to the maximum borrowable amount of $1,141,825 in 2024. Reverse mortgages can have fixed or variable interest rates that can sometimes be a little higher than regular home loans depending on the deal. They also require you to be 62 years of age or older to apply.

Basis Step-Up and Reverse Mortgage to the Rescue

One of the unfortunate side effects of selling your highly appreciated home can be the taxable gain that exceeds the federal home sale gain exclusion tax break up to $250,000 for unmarried taxpayers and $500,000 for married couples filing jointly. The taxes on these sales can be extremely overbearing, especially if you live in a state with a personal income tax. Choosing to take out a reverse mortgage on your property can help you avoid the hefty tax bill that comes with selling your property while still providing you with the money you need. Additionally, reverse mortgages come with the benefit of the tax-saving basis step-up rule which says that the federal income tax basis of an appreciated capital gain asset owned by a person who dies, including a personal residence, is stepped up to fair market value (FMV) as of the date of the owner’s death. This means that if the value of your home stays relatively the same between the date of your death and the date of sale by your heirs, the taxable gain will be much smaller because the sale proceeds will be almost completely offset by the stepped-up basis.

The Reverse Mortgage Angle

Due to the basis step-up rule, holding on to your highly appreciated property can save you lots of money in taxes while still providing you with the cash you need and not forcing you to relocate. Since payments to the lender don’t need to be made until you move out or pass away, that allows you to utilize the tax basis step-up rule and pay off the reverse mortgage from the sales proceeds of your home after you pass away and all remaining proceeds can go to your estate.

Consider the Options

When you need cash, there can sometimes be very few options. Choosing to sell your home can result in large tax bills and the cost of relocation. A reverse mortgage allows you to stay in your home while raising the cash you need at the cost of some fees and interest charges. If those are a fraction of the taxes that you could permanently avoid by staying in your home and benefitting from the basis step-up rule, a reverse mortgage may be a tax-smart solution.

Contact your Wegner CPAs Tax Advisor for any questions or for tips on other home-related strategies.

Would you like to learn more?

Join our email list to receive our most recent blog posts, notification of upcoming seminars, and access to new resources!

Stay Connected
More Updates