Reverse Mortgage Interest on Home sold

[dhoyt]

A client had a reverse mortgage on his primary residence for several years (Mortgage origination date is 2010). He sold the home in 2020. He received a 1098 showing mortgage interest of $25,000 and Mortgage insurance premiums of $10,000. Here are the quesions I have:

Is any portion of the $25k Mortgage interest deductible? I dont believe so because the IRS views a reverse mortgage as  Home Equity debt which is not deductible unless he used the money to buy or improve the home in some way

Is any portion of the mortgae insurance deductible? Again I believe it is not if loan was not used to buy or improve the home

It may seem like I'm asking and answering my own questions. Just looking for a bit of a confirmation on those points and I thank you in advance.

[rbynaker]

It's going to depend on the facts and circumstances.  If there was an existing mortgage which was comprised of home acquisition debt that was rolled into the reverse mortgage at inception then part of the interest paid will still be based on refinanced home acquisition debt and be deductible.  You just have to dig through the history and find out what happened.

I haven't seen enough of these to know which is more common.  I suspect you're right and the vast majority of the interest will be non-deductible home equity interest but you just have to start turning over stones and see what you find.

Rick

[dhoyt]

Thank you very much for your assistance. With all of that in mind I asked taxpayer what the situation was on the reverse mortgage (which I was planning to do when I had a full grasp of the handling of Reverse mortgage interest), and I think it just got a lot simpler. He said he bought the home cash, and then immediately took out the reverse mortgage and took a lump sum distribution of $65k. He used all of that money to completely gut and remodel the home. He never received any other payments from the reverse mortgage. So my understanding is the entire mortgage interest and mortgage insurance would be deductible because all the debt was used to substantially improve the home.

[rbynaker]

In theory that sounds right.  In practice there are all sorts of detailed "tracing" rules you have to follow.  I think it's 1.163-10T (but it might be 8T, I get those mixed up sometimes).  There are some safe harbors if everything was done quickly but I had a nightmare one a few years ago where HELOC money was just dumped into a regular checking account, mixed with paychecks, bought groceries, paid contractors, car payments, credit cards, etc. (and on the credit cards were Home Depot charges for materials used by the contractors to make the improvements so follow the bouncing ball).  I had to spreadsheet everything coming in and everything going out and see how much of the contractor money was (or could be deemed to have been) paid from HELOC money.

[dhoyt]

Yikes! What a nightmare. In this case the taxpayer swears all of the money he received was put into the house. If he gets audited of course he will have to prove that. The decision to deduct the mortgage interest of course is his so if he chooses to do so I will inform him of and make sure he has records to prove everything and trace the money if the IRS makes him do so