There are upfront costs and fees with reverse mortgages, and the basis step-up rule affects the calculation.
For seniors who want to tap into the equity in their homes, reverse mortgages are an option. They can provide a convenient source of cash for those who are house-rich but cash-poor. And there can be a big tax-saving bonus. Here’s what you need to know about reverse mortgages, including the tax angle.
Seniors often cannot qualify for conventional “forward” home equity mortgages due to low income. But they can qualify for reverse mortgages. However, as with any major borrowing transaction, it’s important to find a good interest rate and acceptable up-front charges. Up-front charges for a reverse mortgage can be higher than costs for a conventional mortgage.These days, most reverse mortgages are home equity conversion mortgages, or HECMs, which are insured by the federal government.
Thankfully, there’s a potential solution that involves taking out a reverse mortgage on your property instead of selling. That way, you can take advantage of the tax-saving basis step-up rule explained below. If you’re married and your spouse predeceases you, the basis of the portion of the home owned by your departed mate, typically 50%, gets stepped up to FMV. This usually removes half of the appreciation that has occurred over the years from the federal income tax rolls. So far, so good. If you then continue to own the home until you pass away, the basis of the part you own at that point, which will usually be 100%, gets stepped up to FMV as of the date of your death .
How does the reverse mortgage strategy work? As you can see, holding onto a hugely appreciated residence until death can save a ton of taxes thanks to the basis step-up rule. However, if you need cash right now to make ends meet, we have not yet solved that part of the equation. Enter the reverse mortgage strategy.
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