Deducting a reverse mortgage

By KATHLEEN PENDER
San Francisco Chronicle
Wednesday, June 13, 2007

You've got questions, we've got answers.

Q: Harold P. asks, "I have a reverse home mortgage. I understand that I cannot deduct interest on my home mortgage on my income tax return until I actually pay the interest. (Interest on a reverse mortgage is added to the loan balance each year but is not paid until the loan is repaid, usually at maturity or when the home is sold.)

"I will be paying approximately $20,000 per year interest on paper until I sell my home. If I sell my home in five or 10 years, I will have paid $100,000 to $200,000 in interest. I can't believe the government will allow me to deduct that amount when I sell my home. Isn't there some way I can deduct that interest while the interest is accumulating before I sell my home?"

A: Last question first: No, for practical purposes, Harold cannot deduct the interest each year while it is accumulating.

The only way he could do this is if he switched to the accrual method of accounting, which is not generally feasible for individual taxpayers, who typically use the cash method, says Michael Gray, a certified public accountant in San Jose, Calif.

First question: Harold's tax deduction could be limited, depending on how he used the money.

In general, you can deduct interest on up to $1 million in mortgage debt secured by your home as long as you use the money to buy, build or substantially improve that home.

If you borrow money secured by your home and use it to do anything other than to buy, build or improve your home, the loan is considered home equity debt. In general, you can deduct interest only on up to $100,000 in home equity debt. (The $100,000 limit applies to the amount of debt, not the interest payment on that debt.)

Assuming he had no other debt on his house, if Harold took out a reverse mortgage for $250,000 and used $50,000 to remodel his kitchen and $200,000 to buy a car, take a trip and pay medical bills, he could deduct interest on only the first $150,000 worth of debt.

Note: Home equity debt is not deductible under the alternative minimum tax.

Q: Every time an airline flies out of bankruptcy, I get a question like this one from John A.

"I am having a hard time understanding how Delta Airlines can emerge from bankruptcy protection and declare the previously issued stock as worthless when there were existing assets. Then, the existing assets are used as the basis to issue new stock and the previous stockholders receive nothing in return. I sent an e-mail to investor relations at Delta and received an answer advising me to click on a link to SEC filings.

"They did not answer my question. Can you help me understand how this can happen? Is there any recourse for the shareholders that were left holding onto these worthless shares?"

A: When a company files for bankruptcy, its assets usually exceed its debts. Creditors -- the people who lent money to the company -- have a higher claim on its asset than stockholders.

If the bankrupt company were to be liquidated, shareholders would get nothing and creditors would likely get back less than 100 percent of what they were owed. So many times, creditors agree to relinquish some of their claims in exchange for stock in the reorganized company.

When this happens, the old shares are canceled and the company emerges from bankruptcy with new shares owned mainly by creditors and in many cases management.

The only recourse old shareholders have is to claim a tax loss on their investment.

I'm surprised that Delta didn't point John to the explanation it posted on its Web site at www.delta.com/help/faqs/investor_relations/index.jsp#status.