The June 24th issue of the Everett WA Herald has a clearcut explanation of both taxation of reverse mortgages and when interest paid on them can be deducted.
Here are a couple of key concepts from the article.
When you take out a reverse mortgage you receive a sum of money from the bank.
Since the bank requires no payments until the last borrower no longer inhabits the house, the debt grows larger each year.
The unpaid interest is added to the loan balance each month.
Eventually the loan is paid off when the home is sold - usually after owner's death.
Loan proceeds are not taxable income because the money must be paid back. (If you choose to sell your home after taking out a reverse mortgage, you must repay the outstanding balance, and of course you keep any proceeds that remain.)
As long as your profit on the sale was $250,000 or less - $500,000 for a married couple - all sale profits would be tax free.
Here's another difference in tax consequences: because no interest is actually paid on the mortgage until the home is sold, the interest deduction can not be claimed until that time.
Suppose for example that you decided to sell your house after accumulating $40,00 worth of unpaid interest. In that case, you could claim the $40,000 mortgage interest tax deduction for the tax year in which the home was sold.
I thought this newspaper article provided a pretty clear explanation of these points, but remember - anytime you are talking tax implications it's always a good idea to consult with an experienced tax advisor.
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