Reverse mortgage interest deductible by heirs?

Client died in 2019. She had a reverse mortgage on her home. Estate sold the house and distributed after mortgage proceeds to the three heirs. I can trace $159k of mortgage proceeds to original acquisition and subsequent home improvements. Thus, estate entitled to mortgage interest deduction to that extent. In light of proposed REG-113925-18, can the beneficiaries deduct their proportionate share of the “excess deductions” related to the mortgage interest as mortgage interest (provided they don’t already have a second home or exceed the mortgage limits)? I found an article saying that a home with a reverse mortgage sold by the estate would prevent heirs from being able to claim a mortgage interest deduction vs the heirs themselves selling the home? I can’t find anything authoritative clarifying this difference.

Would the heirs get the deduction under 691(b) as a "deduction in respect of a decedent"?

DRD relates to expenses incurred relating to the decedent's business property or property used for the production of income. Our expenses relating to the decedent's personal residence qualified as DRD?

How can a reverse mortgage be acquisition debt and, thus, deductible?

The decedent still owed money on her original mortgage from when she bought the house when she did the reverse mortgage. Then she took a little more money over the years to do various improvements.

DRD relates to expenses incurred relating to the decedent's business property or property used for the production of income.

Where does 691(b) restrict DRD to business property or property used for the production of income? It says:

The amount of any deduction specified in section 162, 163, 164, 212, or 611 …

Essentially interest accrued up to date of death is mortgage interest deductible by the estate to whatever extent it would have been deductible by the decedent. (Yes , deduction in respect) Interest accrued from date of death to sale is investment interest absent personal use.

Thank you. Are you saying then that each beneficiary can treat their portion of the excess deductions on termination of the estate that is considered “qualified residence interest” (pre-death acquisition interest) as mortgage interest expense on their individual returns and a small amount as investment interest expense (post death interest accrual)?

no

Maybe this question needs a new topic, but I think not. I refer to Dennis2's post #7, which makes cmplete sense to me. But then I thought about the fact that the interest on reverse morgages is added each year (or month) to the balance of the mortgage, i.e., it becomes a part of the (nonrecourse) mortgage. In effect it is compound interest (but that's just an aside). [Wait, I see there is a relevant TPT thread, and I started it. Memory issue? Uh-oh. viewtopic.php?f=8&t=3726]

Which made me think of what we have (here on TPT) sometimes called "hard debt" as distinguished from "soft debt". Hard debt would be, e.g., debt that even for a cash method taxpayer creates basis, such as a mortgage on a home, or a deduction, such as medical expenses paid by credit card. Soft debt would be, e.g., accrued patroll for a cash method DRE. So I guess my question, as best I can articulate it, is what, if any, effect does the fact that the interest on the reverse mortgage is added to the mortgage have on the treatment as expenses in respect of a decedent?

I'm guessing none but thought I'd ask.

Here's where I'm at with this. Reverse mortgage proceeds are treated as home equity debt unless the reverse mortgage proceeds are used to purchase or improve your home. To the extent reverse mortgage proceeds can be considered acquisition debt, the interest allocable to the acquisition debt would be deductible upon repayment. On an estate income tax return, deductible reverse mortgage interest would be considered qualified residence interest if the residence is a qualified residence of a beneficiary who has a present or residuary interest in the estate. Assuming in my client's case, the answer is yes, the interest paid during 2019 on the reverse mortgage considered acquisition debt would be deductible on the final 1041 for the estate.

Now in my case, this interest deduction has created a very large excess deductions upon the termination of the estate. There are three beneficiaries. Now my question is "can the beneficiaries deduct their portion of the excess deductions considered qualified mortgage interest on their individual returns under proposed REG-113925-18"?

"Each deduction comprising the excess deductions under section 642(h)(2) retains, in the hands of the beneficiary, its character (specifically, as allowable in arriving at adjusted gross income, as a non-miscellaneous itemized deduction, or as a miscellaneous itemized deduction) while in the estate or trust. An item of deduction succeeded to by a beneficiary remains subject to any additional applicable limitation under the Code and must be separately stated if it could be so limited, as provided in the instructions to Form 1041, U.S. Income Tax Return for Estates and Trusts and the Schedule K-1 (Form 1041), Beneficiary's Share of Income, Deductions, Credit, etc., or successor forms.[2]"

It sounds to me like the answer is yes. Just hoping for someone to agree with me.

I found an article saying that a home with a reverse mortgage sold by the estate would prevent heirs from being able to claim a mortgage interest deduction vs the heirs themselves selling the home? I can’t find anything authoritative clarifying this difference.

See https://tcbdavison.files.wordpress.com/ ... l-2016.pdf

The issue seems to be who(estate or beneficiares) has enough income to absorb the deduction. In a non final year, the estate may not have enough income to absorb the deduction, therefore most of it it would be lost. Better then to distribute the home in kind to the beneficiaries who may have other income, and let them sell the home and payoff the reverse mortgage and get the deduction.
Note also, with regard to the interest on acquisition indebtedness, only the simple interest will be treated as deductible, not the interest on interest( or home equity interest).

The provision that allows the heir(s) to claim the interest deduction is Reg. 1.691(b)-1, which reads, in relevant
part:
1.691(b)-1. Allowance of deductions and credit in respect of decedents.
— (a) Under section 691(b), the . . . interest . . . described in sections . . . 163 for which the decedent . . . was liable, which were not properly allowable as a deduction in his last taxable year or any prior taxable year, are allowed when paid —
(1) As a deduction by the estate; or
(2) If the estate was not liable to pay such obligation, as a deduction by the person who by bequest devise, or inheritance
from the decedent acquires, subject to such obligation, an interest in property of the decent . .

To the extent the interest would have been deductible by the decedent it can be part of the total excess deductions on termination. It is no longer mortgage interest, merely an itemized deduction. Investment interest is applied against investment income and can never be part of excess deductions. Many years ago there was a k-1 line item for investment interest carryover on a final return. It was not code specific (either yes or no) and there was no change in the law when it disappeared.

You need the closing statement for the mortgage to determine fees and perhaps points all of which became part of the amount borrowed. You also need the interest schedule from the lender.

Why not capitalize the interest (and other carrying charges) on the home, and use it as part of the basis when the home is sold(If the house was only being held for sale/appreciation)?

Does a house held only for sale/appreciation qualify for a reverse mortgage? Don't think so.

No, but any interest being paid on a house held for sale/appreciation would be considered a carrying charge, would it not?

§ 1.266-1(b)(2)

An item not otherwise deductible may not be capitalized under section 266.

No, but any interest being paid on a house held for sale/appreciation would be considered a carrying charge, would it not?. That's just a rumor.

The items thus chargeable to capital account are:

(i) In the case of unimproved and unproductive real property: Annual taxes, interest on a mortgage, and other carrying charges.

(ii) In the case of real property, whether improved or unimproved and whether productive or unproductive:

(a) Interest on a loan (but not theoretical interest of a taxpayer using his own funds),

(b) Taxes of the owner of such real property measured by compensation paid to his employees,

(c) Taxes of such owner imposed on the purchase of materials, or on the storage, use, or other consumption of materials, and

(d) Other necessary expenditures,

paid or incurred for the development of the real property or for the construction of an improvement or additional improvement to such real property, up to the time the development or construction work has been completed.

if your position is that disallowed investment interest can be capitalized, i disagree.

You talkin' to me?