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.