What Home Improvements Are Tax Deductible – It’s no secret that finishing your basement will increase your home’s value. What you may not know is that you may be eligible for tax credits for capital improvements on your home when you sell.
Tax rules let you add capital improvement expenses to the cost basis of your home. Why is this a big deal? Because a higher cost basis lowers the total gain — capital gain, in IRS speak — on which you may be required to pay taxes in some cases. In other words, you may have a tax advantage. Here’s how to know which home improvements can pay off at tax time.
What Home Improvements Are Tax Deductible
The tax benefit does not come into play for everyone. The vast majority of home sellers will never have to pay taxes on the gains they make on their homes because of a widely available exemption on the first $250,000 of gain for single filers ($500,000 for joint filers).
Homeowner Tax Deductions
If you move frequently, it may not be worth tracking capital improvement expenses. But if you plan to live in your home for a long time or make a lot of upgrades, storage receipts can be a smart move.
While you may consider all the work you do to your home an improvement, the IRS sees things differently. A rule of thumb: A capital improvement increases your home’s value, while an ineligible repair only returns something to its original condition.
According to the IRS, capital improvements must last for more than one year and add value to your home, extend its life, or adapt it to new uses.
There are limitations. The improvements should still be evident when you sell. So if you put in wall-to-wall carpeting 10 years ago and then replaced it with hardwood floors five years ago, you cannot consider the carpeting a capital improvement.
Guide To Home Improvements Tax Deduction
Repairs, such as painting your house or repairing hanging gutters, do not count. The IRS describes repairs as things done to maintain a home’s good condition without adding value or extending its life.
There can be a fine line between a capital improvement and a recovery, says Erik Lammert, former tax research specialist at the National Association of Tax Professionals. For example, if you replace some shingles on your roof, that is a repair. If you’re replacing the entire roof, it’s a capital improvement. The same goes for windows. If you are replacing a broken pane, repair. Insert a new window, capital improvement.
One exception: If your home was damaged in a fire or natural disaster, anything you do to restore your home to its pre-loss condition counts as a capital improvement.
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Closing Costs That Are (and Aren’t) Tax Deductible
To figure out how improvements affect your tax bill, you first need to know your cost basis. The cost basis is the amount of money you spent to buy or build your home, including all the costs you paid at closing: attorneys’ fees, recording fees, transfer taxes and home inspections, to name a few. You should be able to find all of those costs on the settlement statement you received at your closing.
Next, you need to account for any subsequent capital improvements you’ve made to your home. Let’s say you bought your home for $200,000, including all closing costs. This is the initial cost base. You then spent $25,000 renovating your kitchen. Add that up and you get an adjusted cost basis of $225,000.
Now suppose you have lived in your home as your main residence for at least two out of the last five years. Any profit you make on the sale will be taxed as a long-term capital gain. You are selling your home for $475,000. This means you have a capital gain of $250,000 (the $475,000 sale price minus the $225,000 cost basis). You are single, so you get the exemption for the $250,000 gain. End of the story.
Here is where it gets interesting. If you didn’t factor in the money you spent on the kitchen remodel, you’d be facing a tax bill on that $25,000 gain that exceeded the exemption.
Ways To Finance Home Improvements
By keeping receipts and adjusting your basis, you saved about $3,800 in taxes based on the 15% tax rate on capital gains. Worth taking an hour a month to organize your home improvement receipts, don’t you think?
The highest profit rate for most home sellers is 15%. For sellers in the highest tax brackets, such as 37%, the cap profit rate is 20%.
Some situations can lower your tax basis and thus increase your risk of facing a tax bill when you sell. Consult a tax advisor. Examples include:
This article provides general information about tax laws and consequences, but should not be relied upon as tax or legal advice applicable to specific transactions or circumstances. Consult a tax professional for such advice. Whether you live in a popular residential market like Seattle, San Francisco, or New York, or simply have lived in the same home for several decades, it’s more common than ever for households to realize taxable gains when they sell their home.
Tax Rules For Deductions On Repairs And Maintenance
Taxable gains from the sale of a primary residence occur when the gain from the sale is above the $250,000 gain exclusion for an individual and $500,000 for a couple. This gain exclusion is available to households that meet the following criteria:
The profit is calculated by deducting selling expenses and your adjusted cost basis in the property from the sale price. The adjusted basis is what you previously paid for the home plus the cost of improvements. Since you are subject to federal capital gains tax, state tax (where applicable) and the 3.8% Medicare surtax (in many cases since the taxable gain can be substantial), keeping track of your improvement history can result in significant savings on your taxes.
Repairs described in the next section may be included in your improvements if they are done as part of an extensive remodeling or repair. The IRS provides the following example: “replacing broken window panes 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 cannot be included in your adjusted basis:
Tax Returns, Deductions, And Credits
Whether requested by a potential buyer, filing your personal tax return the year of the sale, or by the IRS in an audit, it is important to have proper documentation of all your improvements that affect your basis. This includes copies of purchase orders, receipts, canceled checks and any other documentation. Make a special folder for this purpose and keep a running total of your improvement history. Like 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 site such as a Box or Google Drive. At the very least, keep a digital copy of your running total (like a spreadsheet) so you won’t be put in the position of having to one day recreate your improvement history from scratch.
Keep these records as long as you own the home. It is recommended that you keep all improvement-related records for at least three years after you file your tax returns for the year of sale. There are several homeowner’s record keeping books available on Amazon.com or at your local bookstore that can help you organize and keep track of these expenses.
Be sure to keep your own copies of these records rather than relying on others to keep them for you. Many companies and professionals purge records that are more than 10 years old and/or may lose track of them over time.
Before 1997, you could defer realizing a gain on the sale of your home by subsequently buying a home of equal or greater value. Individuals 55 or older were also eligible to use a one-time $125,000 gain exclusion on their home if they purchased a home of lesser value after generating a gain. After 1997 home sales were no longer subject to these rules (unable to defer the gain) and instead received the more favorable gain exclusion described above.
Top Homeowner Tax Deductions That Decrease Your Tax Burden
If you sold your previous home before mid-1997 and deferred paying the tax on any gain at that time by transferring your basis to your existing property, that basis affects your home’s basis. This means that you need to have proper records to prove your previous home’s basis as well, especially since the gain can be much larger making your gain taxable.
Any depreciation previously taken on your tax return, whether for your primary residence that is a rental (at some point) or a home office (business purposes), must be recaptured when you sell your property. This means the amount of depreciation taken to offset previous years’ income 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 untainted section 1250 gain.
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