Sale-leaseback may offer more benefits than reverse mortgage.

• Author: Taylor, Rick J.

It is not unusual for an elderly client to find that he has a large amount of cash invested in his personal residence. For example, some fairly wealthy clients have between 60% and 70% of their net worth tied up in their homes. Very often, this cash may be needed to supplement the resident's income in later years. In response to this need, financial institutions and mortgage companies in 1980 began offering "reverse mortgages." However, because demand far outstrips supply, elderly residents often pay a steep price for the access to cash that reverse mortgages provide. A more beneficial alternative may be to structure a sale-leaseback of the residence between an elderly resident and his children.

Reverse mortgages

A reverse mortgage is an arrangement in which a home owner is allowed to borrow against the equity in his home and to periodically receive the loan proceeds (minus the interest). Generally, the reverse mortgage is for a fixed term of between five and 10 years. Some lenders also offer a lifetime reverse mortgage, provided the lender is given between 50% and 100% of any future appreciation on the property.

Because the proceeds of a reverse mortgage constitute borrowed funds, they are not subject to income tax. If the loan is secured by a qualified residence, the interest should be deductible under Sec. 163 when paid in cash. If the interest is deducted by the lender from the amount paid to the borrower or if the interest is added to the amount owed, the borrower generally is not entitled to the deduction until the debt ultimately is paid. (See Battelstein, 611 F2d 1033 (5th Cir. 1980), rehearing en banc, cert. denied; and IRS Letter Ruling 8324003.) Therefore, in most cases, deduction of the interest will be postponed until the reverse mortgage arrangement is terminated. If the arrangement is not terminated until after the resident's death, the deduction may not be used.

Because the elderly resident continues to own the home, its full value must be included in the decedent's estate when he dies (Sec. 2031). However, any amounts payable to the lender will be deductible under Sec. 2053 for estate tax purposes. The amount deductible should include any shared appreciation that must be paid to the lender (IRS Letter Ruling 9026041). The interest will be deductible (to the extent not deductible during the reverse mortgage term because it was not "paid") for income tax purposes as expenses in respect of a decedent under Sec. 691(b)(1)...