Reverse Mortgages

The IRS considers a reverse mortgage a loan, and because funds received by way of a loan are not considered income, the amount(s) the borrower(s) receive at any given time are not taxable.

According to IRC Section 451, and Treasury Regulation Section 1.451-2, the answer is no.<br /> <br /> Interest on a reverse mortgage added monthly to the outstanding loan balance as it accrues is neither includible in a cash method lender’s gross income, nor deductible by a cash method borrower at the time it is added.

No, repayment can be accomplished in a number of different ways. If the heirs – or any one heir – want to buy the house, they can pay off the loan and take title. This can be accomplished by putting up the cash required to pay off the loan, by using a conventional mortgage, or using a home equity loan on another property. In reality, the financing options available are limited only by the imagination and credit worthiness of the buyer. If someone wants to buy the property, the only obstacle that they are likely to encounter will be how to come up with the entire amount of the existing mortgage balance regardless of the home’s appraised value.<br /> <br /> There is also nothing stopping a would-be buyer from negotiating the price for which the lender is willing to sell the house; this is particularly true in cases where the market value of the house won’t cover the loan.

<div class="Section1">A reverse mortgage is a loan where the lender pays a homeowner (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while he or she continues to live in the home. With a reverse mortgage, the homeowner retains title to the home. Depending on the plan, a reverse mortgage becomes due with interest when the homeowner moves, sells the home, reaches the end of a pre-selected loan period, or dies. Because reverse mortgages are considered loan advances and not income, the amount received is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until the loan is paid in full. The deduction may be limited because a reverse mortgage loan generally is subject to the limit on home equity debt.<a href="#_ftn1" name="_ftnref1">¹</a> A lender commits itself to a principal amount, not to exceed 80 percent of the property’s appraised value.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> Although available through the private sector, the vast majority of reverse mortgage borrowers choose to use a Home Equity Conversion Mortgage (HECM), which are regulated by the Department of Housing and Urban Development (HUD) and only available through an approved Federal House Administration (FHA) lender.<br /> <br /> <hr /><br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  IRS Publication 17.<br /> <br /> </div>

Assuming that the reverse mortgage is not called due to the failure of the borrower(s) to comply with the terms and conditions of the loan, the final settlement of the loan will come due when the borrower(s) sell the home, die, or no longer use the home as the primary residence. At that time, the heirs or estate have six months (this can be extended for a second six months) to repay the lender the principal plus accrued interest, and any other legitimate charges associated with the loan. Should the amount generated from the sale of the home be greater than the amount owed to the lender, all proceeds remaining belong to the borrower(s), heirs, or estate. However this is a “nonrecourse” loan which means that the borrower can never owe more than the value of the home regardless of loan balance; as such, no debt can ever be passed along to the heirs or estate.

It is often suggested that funds received from a reverse mortgage do not affect either government or private retirement benefits; however, there have been cases where the government considered those funds as assets, which resulted in disqualification for Medicaid.<br /> <br /> The following are three examples when funds from a reverse mortgage can affect government benefits:<br /> <blockquote>(1)     If a borrower is on Medicaid, any reverse mortgage proceeds he or she receives must be used immediately to stay within state and/or federal government guidelines for Medicaid recipients.<br /> <br /> (2)     Any funds that are retained by a borrower count as an asset and must be included when calculating Medicaid eligibility.<br /> <br /> (3)     Any income that is generated from the investment of funds received from a reverse mortgage – depending on the tax status of the investment vehicle being used – may be required to be included in the amount of Social Security benefits that are taxable, and at the level those benefits are taxed.</blockquote><br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> According to the National Reverse Mortgage Lenders Association, a taxpayer can prevent losing Medicaid coverage by spending all reverse mortgage proceeds in the same calendar month. Only the amount that remains the following month counts as an asset.<br /> <br /> <hr />

<div class="Section1">There are situations where taxpayer could potentially receive reverse mortgage disbursements within the first 12 months that exceed the limitations imposed for loans issued on or after September&nbsp;30, 2013. While the maximum disbursement that a taxpayer is generally entitled to receive from a reverse mortgage at the time the loan is closed, or within the first 12 months after closing, is now limited to 60&nbsp;percent of the principal limit, the taxpayer may also elect to receive the sum of his or her mandatory obligations plus 10&nbsp;percent of the principal limit (<em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8197">8197</a>).<a href="#_ftn1" name="_ftnref1">¹</a><div class="Section1"><br /> <br /> The borrower under a reverse mortgage may receive initial disbursements of more than 60&nbsp;percent of the principal limit in several situations, including the following:<br /> <blockquote>(1)&nbsp; the taxpayer&rsquo;s mandatory obligations initially exceed 60&nbsp;percent of the principal limit, or<br /> <br /> (2)&nbsp; the taxpayer&rsquo;s mandatory obligations exceed 50&nbsp;percent of the principal limit and the taxpayer elects to receive the full additional 10&nbsp;percent of his or her principal limit.</blockquote><br /> <span style="font-weight: 400;">If the borrower&rsquo;s initial disbursement at the closing (or other disbursements within the first 12 month period) exceeds 60 percent of the principal limit, the cost of the reverse mortgage will increase. Rather than charging an initial mortgage insurance premium (MIP, <em><em>see</em></em> Q <a href="javascript:void(0)" class="accordion-cross-reference" id="8192">8192</a>) of 0.50&nbsp;percent of the maximum claim amount, the borrower&rsquo;s initial MIP will increase to 2.50&nbsp;percent.</span><a style="font-weight: 400;" href="#_ftn2" name="_ftnref2">²</a><br /> <br /> </div><div class="refs"><br /> <br /> <hr align="left" size="1" width="33%"><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.&nbsp; HUD Mortgagee Letter 2013-27.<br /> <br /> <a href="#_ftnref2" name="_ftn2">2</a>.&nbsp; HUD Mortgagee Letter 2013-27.<br /> <br /> </div></div><br />

<div class="Section1">Eligibility for a reverse mortgage is dependent upon:<br /> <blockquote>(1)  The titleholder for the property must be at least 62 years old, and if title is held jointly, the youngest of the two titleholders must be at least 62.<br /> <br /> (2)  The property must be a single family home, an FHA approved condo, or a multiple family dwelling consisting of at least two, but no more than four, units.<br /> <br /> (3)  The home must be occupied by and be the primary residence of the borrower(s).<br /> <br /> (4)  There must be enough equity in the home to cover the payoff of all existing mortgages, liens, or legal obligations tied to the home.</blockquote><br /> The above listed requirements for eligibility are based on those that have been set by HUD for their Home Equity Conversion Mortgage Program (HECM) which covers over 90 percent of all reverse mortgages presently being written.<br /> <br /> <hr /><br /> <br /> <strong>Planning Point:</strong> However, it is important to recognize that there is a private market that many borrowers turn to for reverse mortgages. Those who choose this private marketplace may find that these individual or corporate lenders have their own criteria that differ from HECM’s.<br /> <br /> <hr /><br /> <br /> </div>

<div class="Section1">Yes. Known as the HECM for Purchase, this program was designed to allow seniors to purchase a new principal residence and obtain a reverse mortgage within a single transaction.</div><br /> <div class="Section1"><br /> <br /> This program has been available since it was originally introduced as part of the Housing and Economic Recovery Act of 2008, yet has only recently started gaining popularity.<br /> <br /> The Federal Housing Administration (FHA) defines “HECM for Purchase” as a real estate purchase where title to the property is transferred to the HECM mortgagor, where the mortgagor will occupy as a principal residence, and, at the time of closing, the HECM first and second liens will be the only liens against the property. HECM mortgagors must occupy the property within 60 days from the date of closing. Lenders are required to ensure all outstanding or unpaid obligations incurred by the prospective mortgagor in connection with the HECM transaction are satisfied at closing.<br /> <br /> Only properties where construction is completed are eligible for a HECM-for-Purchase.<a href="#_ftn1" name="_ftnref1">¹</a><br /> <br /> The funding of a HECM for Purchase is an area that has generated an unexpected amount of confusion and debate among borrowers and some advisors. In order to help clarify this, the following text has been taken from the Mortgagee Letter 2009-11 dated March 27, 2009, addressed to All FHA-Approved Mortgagees and All HUD-Approved Housing Counseling Agencies:<br /> <br /> <b>FUNDING SOURCES: </b>HECM mortgagors must use cash on hand or cash from the sale or liquidation of the mortgagor’s assets for the required monetary investment. The monetary investment requirement can also be met by the use of approved funding sources as defined in HUD Handbook 4155.1 REV-5, section 2-10, with the exception of the following funding sources which <b>may not</b> be used:<br /> <br /> Sweat Equity<br /> <br /> Trade Equity<br /> <br /> Rent Credit<br /> <br /> Cash or its equivalent, in whole or in part, from the following parties, before, during or after loan closing:<br /> <p style="padding-left: 40px;">The seller or any other person or entity that financially benefits from the transactions, or</p><br /> <p style="padding-left: 40px;">Any third party or entity that is reimbursed, directly or indirectly, by any of the parties described in the previous bullet.</p><br /> FHA prohibits seller contributions (also known as “seller concessions”), the use of loan discount points, interest rate buy downs, closing cost down payment assistance, builder incentives, gifts or personal property given by the seller or any other party involved in the transaction. This includes customary charges that are normally paid on behalf of the borrower by the seller.<br /> <br /> <b>GAP FINANCING: </b>Consistent with existing regulatory requirements in 24 CFR 206.32(a), HECM mortgagors may not obtain a bridge loan (also known as “gap financing”) or engage in other interim financing methods to meet the monetary investment requirement or payment of closing costs needed to complete the purchase transaction. This restriction includes subordinate liens, personal loans, cash withdrawals from credit cards, seller financing and any other lending commitment that cannot be satisfied at closing.<br /> <br /> </div><br /> <div class="refs"><br /> <br /> <hr align="left" size="1" width="33%" /><br /> <br /> <a href="#_ftnref1" name="_ftn1">1</a>.  HUD Mortgagee Letter 2007-06.<br /> <br /> </div>

<div class="Section1"><br /> <br /> No other question generates such a diverse array of answers. When it comes to whether a reverse mortgage can be put into a trust, it take less than 10 minutes to find the desired answer (right or wrong) on the Internet. However, the overriding authority as to whether a reverse mortgage can be put into a specific trust that meets HUD requirements is set out in HUD – Directive Number: 4235.1 Home Equity Conversion Mortgages.<br /> <br /> <strong><span class="bold">4-5 HOME EQUITY CONVERSION MORTGAGES FOR PROPERTY HELD IN TRUST.</span></strong><br /> <br /> HUD will insure HECMs on property in the name of an inter vivos trust, also known as a living trust. In general, a living trust is created during the lifetime of a person; (<span class="italic"><em>as opposed to a testimonial trust which is created by the person’s will after his or her death</em></span>). A living trust is created when the owner of the property conveys his/her property to a trust for his or her own benefit or that of a third party (the beneficiaries). The trust holds legal title, and the beneficiary holds equitable title. A person may name him/herself as the beneficiary. The trustee is under a fiduciary responsibility to hold and manage the trust assets for the beneficiary. The trustee’s responsibilities are set out in the trust agreement.<br /> <br /> Property held in a land trust is eligible for a HECM if the requirements for a living trust are met. Property held in a living trust is eligible for a HECM if the trusts, and borrowers, meet the following requirements:<br /> <br /> <strong><span class="bold">HUD - Directive Number: 4235.1 Home Equity Conversion Mortgages</span></strong><br /> <br /> A.  Conditions for Origination in the Name of a Living Trust.<br /> <blockquote>(1)<span class="bold">  </span>All beneficiaries of the trust must be eligible HECM borrowers at the time of origination and until the mortgage is released [i.e. borrower/beneficiary must occupy the property as a principal residence and new beneficiaries may not be added to the trust]. Contingent beneficiaries, that receive no benefit from the trust nor have any control over the trust assets until the beneficiary is deceased, need not be eligible HECM borrowers.<br /> <br /> (2)  The trustee must sign the mortgage, and the mortgage must be signed by each borrower/beneficiary if necessary to create a valid first mortgage. The borrower/beneficiary must sign the Note and Loan Agreement. The lender may require the signature of the trustee on the Note or the signature of the borrower/beneficiary on the mortgage.<br /> <br /> (3)  The trust shall not be a party to the Loan Agreement. The borrower/beneficiary may issue instructions to the lender to permit the trustee to exercise one or more rights stated in the Loan Agreement on behalf of the beneficiary; i.e. the right to receive loan advances or to request changes in the payment plan.<br /> <br /> (4)  The lender must be satisfied that the trust is valid and enforceable, that it provides the lender with a reasonable means to assure that it is notified of any subsequent change of occupancy or transfer of beneficial interest, and ensures that each borrower/beneficiary has the legal right to occupy the property for the remainder of his or her life.</blockquote><br /> B.  Transfer of the Property Into or From a Trust.<br /> <blockquote>(1)  The borrower under an insured HECM may transfer the property to a living trust without causing the mortgage to become due and payable if the lender finds that the trust meets all requirements that would have applied if the trust owned the property at closing. The lender may require the trust to formally assume the borrower’s obligation to repay the debt as stated in the Note if considered advisable to avoid difficulty in enforcement of the Note and mortgage.<br /> <br /> (2) If the trust is terminated, or the property is otherwise transferred from an eligible trust holding the property, the mortgage will not become due and payable, provided that one or more of the original borrowers who signed the Note and Loan Agreement continue to occupy the property as a principal residence and continue to retain title to the property in fee simple or on a leasehold interest as set forth in 24 CFR Section 206.45(a).</blockquote><br /> </div>