Reverse mortgage interest paid by heir. Deduct or add to basis?

[TAXMAN]

If a heir inherits a house from the deceased with a reverse mortgage on it, and the heir pays off the reverse mortgage to have a clean house to sale, does the heir deduct the interest they were required to pay or does it go back into the basis for future events? Thanks to all

Edited September 25, 2016 by jklcpa
changed title for clarity

[Abby Normal]

The estate would deduct it if it's still in the estate. If the house has been passed out of the estate, then the new owners can deduct it if they don't already have a second home. I guess if they have a second home you could call it investment interest. Hopefully, it's still in the estate.

[BulldogTom]

5 hours ago, Abby Normal said:

If the house has been passed out of the estate, then the new owners can deduct it if they don't already have a second home. I guess if they have a second home you could call it investment interest. Hopefully, it's still in the estate.

I don't think so.  When the home changes hands to the heirs, and they take possession of the home subject to the mortgage liability, that mortgage includes the interest that has accrued to that date.   I don't think it is interest anymore, it is part of the debt that is being assumed by the heirs. 

Tom
Newark, CA

[Jack from Ohio]

I tend to agree with Tom.

[jklcpa]

1 hour ago, BulldogTom said:

I don't think so.  When the home changes hands to the heirs, and they take possession of the home subject to the mortgage liability, that mortgage includes the interest that has accrued to that date.   I don't think it is interest anymore, it is part of the debt that is being assumed by the heirs. 

Tom
Newark, CA

It's true that the accrued interest does add to the outstanding balance of the mortgage since it is considered an additional advance since payments aren't being made.  Generally speaking, interest on a reverse mortgage is only deductible when it is actually paid and also falls under the home equity interest rules.

Now the question is whether the beneficiary inheriting that property can deduct it if he pays off the reverse mortgage. Without research, I'd say that he probably can because he is now the owner, the loan is secured by the property, he has the obligation to pay it off, he makes the payment, AND if he isn't otherwise limited by the home equity rules.  That's probably why Abby mentioned it might be deductible if the heir didn't already have a second home, but even if he doesn't, he still has to worry about the $100K limitation.

[jklcpa]

Adding to my post above, I'd probably deduct it. I don't think the character of the loan or its terms are changed simply because it was inherited. It is still a reverse mortgage, and if it is still in the estate the administrator or executor would handle it the same way the decedent would if still living, and in the heir's hands he is still bound by its terms and is required to pay it off within a certain time frame.
 

From pub 936: Reverse mortgages.   A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. With a reverse mortgage, you retain title to your home. Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full. Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Part II.

 

 

[SaraEA]

Wow, you learn something new here everyday.  It wasn't my question, but thanks everyone for the learning experience.

[Terry D EA]

Thanks Judy for this. I have been looking into this for my mother and have not done any major research. Just from the statement in your post, I now believe this is not a good idea.

[jklcpa]

3 hours ago, Terry D said:

Thanks Judy for this. I have been looking into this for my mother and have not done any major research. Just from the statement in your post, I now believe this is not a good idea.

I changed the title of this topic for clarity and will be starting a new topic shortly to cover advantages and disadvantages of reverse mortgages. 

[BulldogTom]

On ‎9‎/‎20‎/‎2016 at 5:44 PM, jklcpa said:

Adding to my post above, I'd probably deduct it. I don't think the character of the loan or its terms are changed simply because it was inherited. It is still a reverse mortgage, and if it is still in the estate the administrator or executor would handle it the same way the decedent would if still living, and in the heir's hands he is still bound by its terms and is required to pay it off within a certain time frame.
 

From pub 936: Reverse mortgages.   A reverse mortgage is a loan where the lender pays you (in a lump sum, a monthly advance, a line of credit, or a combination of all three) while you continue to live in your home. With a reverse mortgage, you retain title to your home. Depending on the plan, your reverse mortgage becomes due with interest when you move, sell your home, reach the end of a pre-selected loan period, or die. Because reverse mortgages are considered loan advances and not income, the amount you receive is not taxable. Any interest (including original issue discount) accrued on a reverse mortgage is not deductible until you actually pay it, which is usually when you pay off the loan in full. Your deduction may be limited because a reverse mortgage loan generally is subject to the limit on Home Equity Debt discussed in Part II.

 

 

I need to do more research, because we all know the pubs are not substantial authority.  I keep looking at the use of the word YOU in the quote above, and I keep thinking that means the person who took out the mortgage. 

I just don't want to believe that the accrued interest of the decedent can be deductible mortgage interest to the beneficiary who pays off the mortgage.   The rules for deductible mortgage interest say to be deductible it must be to build, improve or acquire the home.  The beneficiary did none of these things.  I think the person who takes out the reverse mortgage can deduct that interest, but the beneficiary fails the tests for deductible interest.

Now, it could be, (and I don't have time to look right now), that there is an exception to the mortgage interest rules for the beneficiary who assumes a reverse mortgage, but I don't think what you provided in the pub above is that proof. 

I think when the mortgage holder dies, the ability to deduct as mortgage interest dies with them.   But I can't prove that either right now.

Tom
Newark, CA

[jklcpa]

2 hours ago, BulldogTom said:

I just don't want to believe that the accrued interest of the decedent can be deductible mortgage interest to the beneficiary who pays off the mortgage.   The rules for deductible mortgage interest say to be deductible it must be to build, improve or acquire the home.  The beneficiary did none of these things.  I think the person who takes out the reverse mortgage can deduct that interest, but the beneficiary fails the tests for deductible interest.

The "build, improve or acquire" rules pertain to home acquistion debt.  Reverse mortgage interest is considered home equity debt that does not have those requirements.

As far as the beneficiary being able to deduct the interest, the property has passed to the heir and heir is now the legal owner of the property, so I think that item (b) below applies and allows it (underlining is mine, for emphasis):

§ 1.163-1 Interest deduction in general.

(a) Except as otherwise provided in sections 264 to 267, inclusive, interest paid or accrued within the taxable year on indebtedness shall be allowed as a deduction in computing taxable income. For rules relating to interest on certain deferred payments, see section 483 and the regulations thereunder.

(b) Interest paid by the taxpayer on a mortgage upon real estate of which he is the legal or equitable owner, even though the taxpayer is not directly liable upon the bond or note secured by such mortgage, may be deducted as interest on his indebtedness.

 

As I said in my earlier post, I think he can take the interest deduction as long as he is able to under the rules pertaining to interest paid on home equity debt.  He is the owner, the loan is secured by the property, he has the obligation to pay it off, he makes the payment.