Reverse Mortgage Interest Deduction

[JohnH]

Taxpayer & wife were living in a home she and her brother had inherited from her parents. There was no mortgage on the house. Taxpayer's wife died in 2008. A few months later the taxpayer had the house appraised for $230K, and taxpayer took out a reverse mortgage to pay the brother (in-law) $115K & acquire full ownership. Reverse mortgage amount was $150K due to some other debts he wished to settle at the time - unrelated to the residence.

Taxpayer lived in the home until 2011, when he remarried and moved into home of new spouse.
From time-to-time, his adult children would live in the house with no rent charged.

In 2014, the house was sold for $220K and the reverse mortgage was paid off.
Payoff amount was $176K.

As I see it, the loss is non-deductible due to the home being taxpayer's primary residence from 2008-2011, and a second residence from 2011-2104.

It's also my understanding that the reverse mortgage interest deduction can be taken when the loan is paid off. But reverse mortgage is considered home equity debt and in this case the interest deduction is subject to the $100K limitation. So I'm thinking a simple way to calculate the interest deduction would be to based it on the ratio of 100K/163K, or 61% of the accrued interest. (The $163K is the average balance over the life of the loan).

Anybody have any thoughts on my method, or am I way off base on the whole matter?

[kathyc2]

Reverse mortgages are not for second homes. In fact, your client should have had to fill out a form annually stating that he hasn't been absent from home for more than 2 months. Copy and paste this into browser to see form: https://www.fanniemae.com/content/fa...tification.pdf

If your client falsified this form, I would say he performed an unlawful act and therefore no deduction.

[JohnH]

H-m-m.
Thanks for that heads up.
I really appreciate the insight and warning.

It was his primary residence for the first 3 years, so he was OK when he obtained the mortgage.

I'll have to ask him if he submitted the recertifications during the remaining years.

Since the loan is now paid off, he is probably OK with respect to the loan itself.
But I see what you mean about the deduction possibly being called into question, although I don't find any clear guidance on the issue.

[New York Enrolled Agent]

H-m-m.
Thanks for that heads up.
I really appreciate the insight and warning.

It was his primary residence for the first 3 years, so he was OK when he obtained the mortgage.

I'll have to ask him if he submitted the recertifications during the remaining years.

Since the loan is now paid off, he is probably OK with respect to the loan itself.
But I see what you mean about the deduction possibly being called into question, although I don't find any clear guidance on the issue.

Rev Ruling 80-248 might be of help.

It was written prior to TRA 86, thus I agree with your thinking on the 100K limitation for equity debt.

[Roland Slugg]

I disagree with the replies above that say the reverse mortgage loan (RML) is a home equity loan (HEL) in this case, limiting the interest deduction to that paid on only $100k of the total principal amount. Although a RML loan is usually a HEL, and thus subject to the limit on home equity debt, that is not entirely true in this case. According to the OP $115k was borrowed to acquire the property, so that portion of the loan represents acquisition indebtedness. Only the additional $35k borrowed was home equity debt.

Since both segments of the total loan are within the interest-deductible limits of $1,000,000 and $100,000 respectively, all interest paid is deductible.

[JohnH]

Well now, that's an interesting twist.
And I like the way it is going...

This forum truly is a "virtual water cooler".

[Stringbean]

Change in Status - Disregard

My vote (if I have one) is for Slugg. Although the status of the home changed in later years, we are told over and over again to look to the purpose of the loan when it is first made.

I've just been through a harrowing analysis with a customer where we had to split hairs on 4 different loans, and have been indoctrinated to the concept of "acquisition" loans and interest. In every case the determination was to revert back to the original purpose of the loan, regardless of how sour it may have ended up.

[JohnH]

Yes, you absolutely have a vote. Every vote counts on this forum, even though it isn't a democracy.

Thanks to all the info presented here, I'm leaning heavily in the direction of acquisition debt, and am briefing the client on their options. This client happens to trend on the ultra-conservative side and wants to avoid the potential for problems with IRS. So it may wind up that we file using it as allocated Home Equity debt, and then I hope for an audit/examination so they can claim the rest.

At first I was concerned about failure of the deduction due to the fact that the Reverse Mortgage was technically in default. However, that's an issue unrelated to the tax deduction itself and I don't find any basis for disqualifying the deduction. An analogy would be a wrap-around mortgage on a home with a due-on-sale clause. There is a technical violation of the loan terms, but that's an issue between the lender and the borrower. IRS doesn't have a dog in that fight. Most preparers would advise to report the interest income and take the corresponding investment interest deduction on Schedule A. This situation is similar, except for the fact that there is no sale and no interest income since fammily members lived in the home and it continued as a second residence.

[kathyc2]

. IRS doesn't have a dog in that fight.

I'm not sure that's true. Originally I was thinking of no deduction for illegal activities but since that's coming from 162, probably doesn't apply here. Sec 163 does reference deduction for "qualified residence". I would think they could take the position that when occupancy requirement was no longer met it ceased to be a "qualified residence". A HUD sample audit revealed there are big problems with RM participants not meeting occupancy requirements. Are they asking IRS to help weed them out? I don't know if they are or not, but I would probably lay it out for client and then let them see if they want to risk having the non-compliance of RM potentially looked at or not.

[JohnH]

I doubt IRS would accept that responsibility, especially given all that is on their plate.
But in this case, even if they did, and even if HUD found about about it, what would the remedy be?
The RM is paid off so I doubt there's anything to be done at this point.
My view might be completely different if the RM were still in place, but then we wouldn't be talking about a deduction at all.

There's no doubt he was OK for the first 3 years - it's only after he got married & moved that the issue arises.

I do appreciate all the cross-checking.
This discussion has enlightened me on RM's significantly.

[nwtaxlady]

What kind of loan taken out?

Was it truly a Reverse Mortgage taken out?? The most common situation you see is similar in that a couple gets divorced and one spouse takes out a Home Equity Line of Credit (HELOC) in order to buy out the other spouses equity. And in this case it is qualified acquisition debt. The extra $ taken out for personal use is equity indebtness (limit of $100,000). Sounds like this is what your client did. But if it was truly a Reverse Mortgage then I am not familiar with how to treat it. Looking at the time... It was a personal residence. And what was their intent?

[JohnH]

Was it truly a Reverse Mortgage taken out?? The most common situation you see is similar in that a couple gets divorced and one spouse takes out a Home Equity Line of Credit (HELOC) in order to buy out the other spouses equity. And in this case it is qualified acquisition debt. The extra $ taken out for personal use is equity indebtness (limit of $100,000). Sounds like this is what your client did. But if it was truly a Reverse Mortgage then I am not familiar with how to treat it. Looking at the time... It was a personal residence. And what was their intent?

Yes, it was was a reverse mortgage. I got some paperwork from him which confirmed that fact. This discussion reallly helped me clarify the issues and also to ask a few questions which had not been on my radar screen.

It's definitely a knotty problem with the interesting issue of "acquisition debt" up in the air, plus the fact that the client certified that it continued to be his residence even after he moved out. We finally came to a reasonable alllocation of the interest after adjusting for all these variables. It's anyone's guess what might happen if he happpens to get audited.