Source: https://www.onefpa.org/journal/Pages/The%20Taxation%20of%20Reverse%20Mortgages.aspx
Timestamp: 2019-04-20 17:19:06+00:00

Document:
Vorris J. Blankenship is a retired attorney and CPA. He is the author of "Tax Planning for Retirees," a treatise published by LexisNexis.
A reverse mortgage allows a taxpayer to draw down home equity tax-free. The taxpayer can generally choose to withdraw the equity as monthly payments, as a lump sum, as a flexible line of credit, or as a combination of those types of payments. Furthermore, the taxpayer need not make mortgage payments so long as the taxpayer (or taxpayer or spouse) continues to live in the home. Interest on the aggregate drawdown generally accrues unpaid until the taxpayer (or taxpayer or spouse) no longer occupies the residence.
Thus, when the taxpayer (or taxpayer and spouse) ceases to occupy the residence, the taxpayer, spouse, or his or her estate or heirs will normally sell the residence and pay the balance of the mortgage and accumulated interest. However, the total repayment is limited to the amount of the proceeds of sale. On the other hand, if there is any remaining equity in the residence, the taxpayer or spouse, or his or her heirs, are entitled to it.
The IRS has specifically ruled that it will not disallow interest paid on borrowings (1) used to make IRA contributions or (2) used in lieu of IRA distributions. The IRS reasoned that IRA income is merely tax-deferred, not tax-exempt.12 The same should be true of most income earned by retirement plans. In contrast, income earned by Roth IRAs or designated Roth accounts may be truly tax-exempt since the income is not taxable when earned and any eventual "qualified" distribution of that income is also nontaxable.
1 Rev. Rul. 80-248, 1980.2 C.B. 164.
2 I.R.C. § 163(h)(3)(B)((i), (C)(i).
3 I.R.C. §§ 163(h)(1), 163(h)(2)(D), 691(b)(1); Treas. Reg. § 1.691(b)-1(a).
7 I.R.C. § 163(h)(3)(A)((ii), (3)(C).
8 Priv. Ltr. Rul. 200940030. To the contrary, see Pau v. Commissioner, T.C. Memo. 1997-43; Catalano v. Commissioner, T.C. Memo. 2000-82.
9 I.R.C. § 56(e), (b)(1)(C)((i).
10 I.R.C. § 164(a)(2), (4); I.R.C. § 165(a)(1), (2), (4).
11 Rev. Proc. 72-18, 1972-1 C.B. 740, clarified by Rev. Proc. 74-8, 1974-1 C.B. 419, modified by Rev. Proc. 87-53, 1987-2 C.B. 669. See also Wisconsin Cheeseman, Inc. v. United States, 388 F.2d 420 (7th Cir. 1968). But see Treas. Reg. § 1.163-10T(b).
12 Priv. Ltr. Rul. 8527082; Priv. Ltr. Rul. 8617044.
15 I.R.C. § 461(g); Rev. Proc. 94-27, 1994-1 C.B. 613 (safe harbor not necessarily applicable to home improvement or refinancing mortgages or to mortgages on second homes).
16 I.R.C. § 461(g)(2); Rev. Rul. 87-22, 1987.1 C.B. 146.
17 Schubel v. Commissioner, 77 T.C. 701 (1981).
18 Treas. Reg. § 1.6050H-1(f)(3)(ii), Example 1; Rev. Proc. 94-27, 1994-1 C.B. 613.
19 Rev. Proc. 87-15, 1987-1 C.B. 624. But see Huntsman v. Commissioner, 905 F.2d 1182 (8th Cir. 1990) (points paid on the refinancing of a short-term purchase loan were immediately deductible since the refinancing was treated as a mere a continuation of the original purchase loan).
21 I.R.C. § 163(h)(4)(E), (F); Treas. Reg. § 1.163-11T; 2008-4 I.R.B. 313, Notice 2008-15.
22 I.R.C. § 165(c); Treas. Reg. § 1.165-9(a).
26 Treas. Reg. § 1.121-1(c)(1), (c)(4) (Example 3).
27 I.R.C. § 121(d)(2); Treas. Reg. § 1.121-4(a).
29 I.R.C. § 121(b)(1), (2); Treas. Reg. § 1.121-2(a)(3).
33 Treas. Reg. § 1.121-3(c), (f).
34 Treas. Reg. § 1.121-3(d), (f).
35 Treas. Reg. § 1.121-3(e).
36 I.R.C. § 121(c)(1); Treas. Reg. § 1.121-3(g).

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