Can Home Improvements Be Tax Deductible – Whether you live in a popular residential market like Seattle, San Francisco, or New York, or you’ve simply lived in the same home for several decades, it’s more common than ever for households to incur taxable gains when they sell their home.
Taxable gains on the sale of a principal residence occur when the gain on the sale exceeds the excluded $250,000 for an individual and $500,000 for a couple. This earnings exclusion is available to households that meet the following criteria:
Can Home Improvements Be Tax Deductible
The gain is calculated by subtracting the selling expenses and your adjusted cost basis on the property from the selling price. Adjusted basis is what you previously paid for the home plus the cost of improvements. Since you’re subject to federal capital gains taxes, state taxes (if applicable), and the 3.8% Medicare surcharge (in many cases, since the taxable gain can be substantial), keeping track of your history of improvements can lead to significant savings on your taxes.
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The repairs described in the following section may be included in your improvements if they are carried out as part of an extensive remodeling or restoration job. The IRS offers the following example: “replacing broken glass is a repair, but replacing the same window as part of a project to replace all the windows in your home counts as an improvement.”
The IRS provides the following examples of repairs and maintenance to your home that may not be included in your adjusted basis:
Whether requested by a potential buyer, filing your personal tax return the year of the sale, or by the IRS in an audit, it’s important to have proper documentation of all improvements that affect your basis. This includes copies of purchase orders, receipts, canceled checks and any other documentation. Create a special folder for this purpose and keep a total of your upgrade history. As with other important financial records, it is recommended that you also keep a digital copy of this information. If possible, scan all documentation to a secure storage location such as Box or Google Drive. At the very least, keep a digital copy of your running total (like a spreadsheet) so you don’t have to recreate your improvement history from scratch one day.
Keep these records for as long as you own the home. It is recommended that you keep all records related to the improvement for at least three years after you file your tax returns for the year of sale. There are several homeowner record books available on Amazon.com or at your local bookstore that can help you organize and keep track of these expenses.
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Be sure to keep your own copies of these records rather than relying on others to keep track of them. Many companies and professionals purge records that are more than 10 years old and/or may lose track over time.
Before 1997, you could defer realizing a gain on the sale of your home by later buying a home of equal or greater value. People 55 and older could also use a one-time gain exclusion of $125,000 on their home if they bought a lower-value home after triggering a gain. Post-1997 home sales were no longer subject to these rules (they could not defer gain) and instead receive the more favorable gain exclusion as described above.
If you sold your previous home before mid-1997 and delayed paying tax on any gain at that time by shifting your basis to your existing property, that basis will affect the basis of your home. This means you must also have the proper records to prove the basis of your previous home, especially since the gain can be much higher making your gain taxable.
Any depreciation previously taken on your tax return, whether your primary residence is a rental (at one time or another) or a home office (for business purposes) must be recaptured when you sell your property. This means that the amount of depreciation taken to offset income from previous years will not be protected by the gains exclusion and will instead be taxed at a rate of up to 25%. The technical term for this is unrecaptured section 1250 gain.
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Removing that in-ground pool or that new roof would be nice, right? Unfortunately, for the most part, home improvements are not tax deductible.
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In fact, with the exception of a few scenarios, most home improvements will have the opposite effect, resulting in higher property taxes.
Are you planning to make some improvements to your home or a rental property you own? Here are some occasions when you can write off your costs.
If your improvements are medically related, you can write off their cost, or at least a portion of them. First, the improvements have to be related to the “diagnosis, cure, mitigation, treatment or prevention” of an underlying disease or medical condition for someone in the household.
In addition, the upgrades must also have been paid for out of pocket and not reimbursed in any way by your health insurance. You’ll also need to itemize your tax return, and expenses must exceed 7.5% of your adjusted gross income for the year. Only the amount that exceeds the 7.5% threshold can be deducted.
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Some energy efficiency improvements may qualify you for tax credits. Technically, these are not tax deductions. Instead of reducing the amount of income you report, they actually reduce your final tax bill — the total amount of income tax you owe to the IRS.
The most notable tax credit is the residential renewable energy tax credit. This allows you to reduce your tax burden by 22% to 30% of your project costs. Some improvements that can be included:
There is also a similar tax credit program for businesses, and depending on your locality, you may qualify for various municipal rebates as well. Check out this resource for possible savings options in your area.
Using home equity lines of credit (HELOCs) and loans can be smart ways to pay for home improvements. Doing so may even qualify you for another tax deduction, allowing you to write off interest paid on your HELOC or home equity loan over the course of the year.
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Here’s the catch, though: To claim the deduction, you must itemize on your tax return. You also need to use the funds to improve the value of the home, specifically to “buy, build or substantially improve” your primary residence.
Finally, there is another caveat. Because it qualifies as a deduction for state and local taxes (SALT), the interest you deduct, plus the state and local taxes you write off with it, can’t exceed $10,000.
As a homeowner, you can write off the interest you pay on your home loan over the course of the year (as long as you itemize it). This can be helpful if you are using a 203k loan, HomeStyle loan, or other home improvement loan to purchase your home and finance the project costs at the same time. Just use the funds as planned and deduct your full interest from your taxable income.
When it comes to home improvements, that’s where the tax deductions end. However, when you sell your home, there’s one more benefit you’ll enjoy: capital gains taxes.
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When you improve the value of a home (called a capital improvement), it increases the cost base of the property and therefore increases the amount of tax-free capital gains you can pocket once you sell. You don’t have to pay capital gains tax if your profit is less than $250,000 if you file single or $500,000 if you’re married filing jointly, and a higher cost basis lowers your profit margin, at least in the eyes from the IRS.
Fortunately, home improvements aren’t the only hope for reducing that tax liability. If you own a home, there are other deductions and amortizations that you could qualify for.
Most of these deductions require you to itemize on your tax returns. To make sure this is the smartest move for your finances, add up your itemized deductions and compare them to the standard deduction you’re eligible for. In many cases,
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