The Strategy: Borrow, Don’t Sell

What if one financial decision could determine whether your family pays capital gains taxes on nearly $4 million of appreciation?

That question is at the heart of one of the most overlooked retirement and estate planning strategies available today.

I recently came across a graphic that perfectly illustrates the concept. While it simplifies the details, the underlying strategy is grounded in current tax law and helps explain why many affluent families choose to borrow against appreciated assets instead of selling them.

Imagine this scenario.

Mom purchased her home decades ago for $80,000. Today, it’s worth $4 million.

If she sells the home during her lifetime, she could trigger a substantial capital gains tax because of the appreciation. Instead, she decides to borrow against the home’s value to supplement her retirement income.

Because reverse mortgage proceeds and other loan proceeds are generally not considered taxable income, she can access liquidity without selling the property or triggering a taxable event, while continuing to live in and own her home.

When Mom eventually passes away, her children inherit the home. Under current tax law, inherited property generally receives a step-up in tax basis to its fair market value at the date of death. If the heirs sell the home shortly thereafter for approximately that value, there may be little or no capital gains tax because the tax basis has been adjusted to the current market value.

The reverse mortgage doesn’t eliminate the loan. Instead, it allows Mom to access a portion of her home’s equity during retirement while preserving the possibility of a stepped-up basis for her heirs under current law.

This strategy doesn’t eliminate debt or taxes altogether. It simply changes when and how they’re addressed.

A Real Reverse Mortgage Conversation

This graphic above reminded me of a recent client.

She was 82 years old and owned a home valued at approximately $4 million. Like many affluent retirees, she had significant wealth tied up in her home but didn’t want to sell it, disrupt her lifestyle, or create an unnecessary tax event during her lifetime.

We evaluated two very different reverse mortgage strategies.

Option 1: FHA HECM

The FHA-insured Home Equity Conversion Mortgage (HECM) would provide approximately $600,000 through a growing line of credit.

Although the initial borrowing capacity was relatively modest, any unused portion of the line of credit would continue growing over time, currently at approximately 6.5% annually. For homeowners who value long-term borrowing capacity and flexibility, this feature can be extremely attractive.

Option 2: Proprietary Reverse Mortgage

The proprietary reverse mortgage offered a very different solution.

Instead of approximately $600,000, it could provide access to nearly $2.3 million immediately. The tradeoff was a higher interest rate, approximately 9.5%, and it generally does not offer the same long-term line of credit growth available through the HECM program.

Why such a dramatic difference?

FHA reverse mortgages are subject to a maximum lending limit. Once a home’s value exceeds that limit, additional equity does not increase the available proceeds. Proprietary, or jumbo, reverse mortgages are specifically designed for higher-value homes and may provide substantially greater borrowing capacity.

If you’d like to learn more about how these loans compare, see my article: “A Better Reverse Mortgage for High-Value Homes.”

Neither option was inherently better. The HECM prioritized future flexibility through its growing line of credit, while the proprietary reverse mortgage prioritized maximum liquidity today. The appropriate recommendation depended entirely on the client’s retirement goals, estate plan, cash flow needs, and overall financial picture.

What Happens When Mom Leaves the Home?

A reverse mortgage is still a loan, and it must eventually be repaid. Repayment generally occurs when the homeowner passes away, sells the home, or permanently moves out, such as into an assisted living or skilled nursing facility for more than 12 consecutive months.

In most cases, the heirs simply sell the home. The reverse mortgage balance, including accrued interest, is paid from the sale proceeds, and everything that remains belongs to the heirs.

Because the home generally receives a step-up in tax basis under current law, the heirs may be able to sell the property with little or no capital gains tax, even though Mom may have purchased it decades earlier for only $80,000.

For many families, this creates a planning opportunity that allows Mom to enjoy the wealth stored in her home during retirement while preserving flexibility for the next generation.

The Bigger Lesson

Too often, retirement planning focuses on what assets should be sold first to generate retirement income. Yet for many retirees, their home is their largest asset, and it is often overlooked as a planning resource.

The modern reverse mortgage creates a third option. It allows qualified homeowners to convert a portion of their housing wealth into generally tax-free loan proceeds while continuing to own and live in the home. For the right client, this can improve cash flow, preserve investment assets, enhance retirement flexibility, and potentially create a more tax-efficient outcome for both the homeowner and their heirs.

As I often say:

The modern reverse mortgage is a proactive retirement income planning tool, cleverly disguised as a mortgage.

The goal isn’t to avoid taxes. The goal is to make smarter decisions about when assets are sold, how retirement income is generated, and which resources are used first. Sometimes, borrowing against an appreciated home instead of selling it can be one of the most effective tools available.

Do You Have the New Book?

If you found this discussion valuable, you’ll find many more planning ideas in my newest book, Using Housing Wealth to Reduce Taxes in Retirement: The Twelve Reverse Mortgage Conversations That Expand Tax Planning Possibilities.

In my fourth book, I explore how reverse mortgages may help reduce lifetime taxes by allowing retirees to rely less on taxable withdrawals from retirement accounts. Structured around twelve practical planning conversations, the book provides financial advisors with a framework for incorporating housing wealth into strategies involving IRMAA management, Roth conversions, Required Minimum Distributions (RMDs), Social Security timing, sequence of returns risk, and other retirement income planning decisions.

Whether you’re a financial advisor, CPA, estate planning attorney, or simply interested in creating a more tax-efficient retirement, this book offers practical ideas that can immediately enhance your planning conversations.

Learn more at:
www.ReduceTaxesInRetirement.net

This article is for educational purposes only and should not be construed as tax, legal, or investment advice. Reverse mortgage proceeds are generally not taxable because they are loan advances, and the loan must ultimately be repaid when the borrower permanently leaves the home. Tax laws are subject to change. Always consult your tax professional and estate planning attorney regarding your individual circumstances.

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Related Articles:

• How Did Reverse Mortgages Get Such a Bad Reputation?
• 37 Frequently Asked Questions About Reverse Mortgages
• Why Waiting to Secure a Reverse Mortgage Could be a Costly Mistake

The content of this blog is for financial advisors and professionals only and is not intended for consumer use. Names, cases, and scenarios are fictionalized for illustrative purposes. The opinions expressed here are those of the author alone and do not reflect the views of any affiliated entities or individuals. Don Graves, NMLS #142667.