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A reverse mortgage pays homeowners in advance for title to their principal residence. The loan comes in the form of a lump-sum or monthly payment, or a line of credit. When the homeowner moves out or dies, the loan is repaid by the heirs of the estate or after sale of the property. Although the IRS allows the deduction of interest paid on a reverse mortgage, there are important limits and conditions attached.
Rules on Reverse Mortgage
FHA rules on the Home Equity Conversion Mortgage govern the reverse mortgage contract. Homeowners must be 62 or older and must own the home free of existing liens. If not, any previous liens must be paid off with the proceeds from the HECM. Lenders will not require a credit check -- repayment of the loan is guaranteed by the sale of the house. While the homeowner remains in the home, he is still responsible for maintaining the house, keeping up on property insurance and paying property taxes.
While you remain in the home, the reverse mortgage loan remains outstanding; there is no required interest or principal payment. If you move or sell the home, however, the loan becomes due along with accumulated interest payments. The IRS considers reverse mortgages to be a form of home equity loan. As with a traditional mortgage, interest on a reverse mortgage is deductible; however, this deduction is limited to interest paid on no more than $100,000 of loan principal. This is the IRS limit on home equity debt.
Interest that you pay on a reverse mortgage is deductible in the year that you pay the interest. Since there is no repayment, in most cases there is no deduction. You may not deduct the interest in advance unless you voluntarily write a check to the lender, who applies the payment to principal and interest, then reports the interest portion to the IRS on Form 1098. If the loan is paid off after the death of the homeowner, the interest deduction would be taken by whoever repays the loan: either the estate or the heirs.
Other Deductible Costs
Although you can't deduct interest on a reverse mortgage until you actually pay it, you can deduct the fees and costs of originating the loan. These include broker fees, document fees and "points" charged to you in return for a lower-than-market interest rate. If you take out a reverse mortgage, you can deduct origination costs on Schedule A, as long as you itemize deductions. Keep a copy of the loan's settlement statement to document these costs to the IRS, if necessary.
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