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A deductible use for reverse mortgages?

Technical topics regarding tax preparation.
#1
Nilodop  
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News article got me thinking. A company that made kitchen cabinets closed after many successful years and fired 1,000 employees. Couple months later, 65-year old business man buys the business, hires back many of the employees, and restarts the business. He had to find financing, and did.

I wondered whether, on a much more modest scale, some retired and bored and healthy senior could use the proceeds of a reverse mortgage to buy a small business. I think so. And if the proceeds of a reverse mortgage are used to buy a business, the interest (including OID) might be deductible (within the relevant rules) as either business interest or investment interest, 163(h)(2) (A0 or (B). I think so.

IRS stuff is way too general and incomplete. Some might say wrong.

Pub 936 -
Reverse mortgages. ... Any interest (including original issue discount) accrued on a reverse mortgage is considered home equity debt and isn’t deductible.


Pub 554 and Pub 17- same thing.

IRS Q&A meant for seniors -
Question
Are the proceeds I receive from a reverse mortgage taxable to me?
Answer
...
Interest (including original issue discount) accrued on a reverse mortgage isn't deductible until you actually pay it (usually when you pay off the loan in full). Also, a deduction of interest may be limited because a reverse mortgage generally is subject to the limit on home equity debt, which is not deductible unless the proceeds are used to buy, build, or substantially improve the home that secures the loan. For information on deducting mortgage interest and the debt limit that applies, see Publication 936, Home Mortgage Interest Deduction.


So am I correct in saying each of these:

If the reverse mortgage borrower is on the accrual method (rare yes, but not unheard of), why must he wait until the interest is paid?

In fact, I think the rules are that OID is deducted each year as it accrues, even for a cash method taxpayer.

And the business equity and assets are not tied up as collateral.

And if he lives beyond his ownership of the assets, he does not have to pay off the loan when he sells the business.

And of course all the bad things about reverse mortgages (other than non-deductibility of interest) are still true, even though not discussed by Alex Trebek, Tom Selleck, et al.
 

#2
Dennis2  
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The 1098 when mortgage is paid is all inclusive, which is problematic because you have to separate the pre-death interest accrual (deductible as it would have been deducted by decedent) and post death which is categorized as investment interest.

Not sure what the entries would look like if business is accrual.
 

#3
Nilodop  
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Duly noted. Thanks.

And I meant that even the individual could be accrual. Not the business.
 

#4
Wiles  
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Are you asking about an accrual basis individual that uses the proceeds to buy, build, improve home?

Or an accrual basis Sch C that uses the proceeds in the business?
 

#5
Nilodop  
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Are you asking about an accrual basis individual that uses the proceeds to buy, build, improve home?

Definitely not.

Or an accrual basis Sch C that uses the proceeds in the business?. Asking about an individual who can be cash or accrual and who uses reverse mtge. proceeds to either buy a small business or use in an existing one.

Basic point is that, absent a better/cheaper financing source, a reverse mtge. can be used for those purposes and still have deductible interest annually, despite statements to the contrary in IRS material.
 

#6
jon  
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Who computes the annual interest amount/rate, are you saying there is only one advance at the beginning for business use? Then accrued interest is different than accounts payable which I believe for income tax purposes can be required to be paid within time limits. Eventually comes the 1098 to reconcile to.
 

#7
Nilodop  
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OID "accrues" annually and, I think, is deductible annually regardless of accounting method.

Or is my whole idea down the drain because of section 1275(b)? Stated differently, does the tracing to business use or investment use negate 1275(d)? Probably not.
Last edited by Nilodop on 8-Oct-2019 5:54pm, edited 1 time in total.
 

#8
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If the reverse mortgage borrower is on the accrual method (rare yes, but not unheard of), why must he wait until the interest is paid?


I don’t think the accrual method individual would have to wait.
In fact, I think the rules are that OID is deducted each year as it accrues, even for a cash method taxpayer.


Right, that’s the general rule. But that rule doesn’t apply if personal use property is involved. But I think you’d say that the asset in question (i.e. the business interest or the business assets) is the asset to be tested, not the residence, thereby rendering the OID deductible by the borrower as it accrues.
 

#9
Nilodop  
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Right, that’s the general rule. But that rule doesn’t apply if personal use property is involved. But I think you’d say that the asset in question (i.e. the business interest or the business assets) is the asset to be tested, not the residence, thereby rendering the OID deductible by the borrower as it accrues.


Yup, that's a good short summary of the issue. First, 163(e)(1) sets a rule that the OID is deducted annually. Then, 163(e)(6) says we have to read 1275(b) for certain loans for personal use.. The heading of 1275(b) is
(b) Treatment of borrower in the case of certain loans for personal use
. I'm arguing we have a loan for business or investment use, not personal use. So I read 1275(b) carefully, and it tells me that (unless I'm that extremely rare accrual method individual, which I'd bet none of us has ever encountered), for debt
... incurred in connection with the acquisition or carrying of personal use property ...
, I can only deduct OID when it is paid. My argument in support of the OID deduction is simply that I incurred the reverse mortgage debt for business or investment purposes, even though the debt is secured by my house, a personal use property. IRS, OTOH, might say I incurred the debt to "carry" the house, because I could not afford my business or investment use unless I sold or borrowed against my house. That argument, of course, would fly in the face of the tracing rules that apply to interest.
 

#10
jon  
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Is not the mortgage always attached to a "personal" residence? Unless part business use of residence it IS personal!?? Tracing rules do apply or residence owner has to be accrual basis. I do remember home improvement costs being traced to get part as a deduction when paid.
 

#11
Nilodop  
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The mortgage is "attached" (using your word) to a personal use property but it is not for acquisition or carrying of personal use property.
 

#12
Noobie  
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jon wrote:Is not the mortgage always attached to a "personal" residence? Unless part business use of residence it IS personal!?? Tracing rules do apply or residence owner has to be accrual basis. I do remember home improvement costs being traced to get part as a deduction when paid.

I always use tracing rules. Unless it is for a Sch A mortgage interest deduction, I don't care what secures the loan.
 

#13
jon  
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Is a reverse mortgage not a Sch A mortgage interest deduction? Noobie
 

#14
Nilodop  
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Not if it's traced to business or investment use.
 


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