Home Improvements Reduce Capital Gains Tax
By: Kay Bell - Bankrate.com
If you stand to cash in big when you sell your home it's important to remember that every dollar spent on home improvements, remodeling and renovations can mean a dollar off your federal tax bill when that day comes.
That's because money spent on capital improvements is subtracted from your profit -- if and when you sell -- and thereby reduces the amount you may have to pay as long term capital gains tax.
This is how it works: When you sell your home very often you get to experience one of the best things about the way your home has by realizing a tidy profit. That's also one of the worst things.
If you net more than the IRS exclusion amount, you'll have to share some of your sale proceeds with Uncle Sam.
Tax law allows a single homeowner to escape an IRS bill on the first $250,000 in home-sale profit and $500,000 for married couples. But some owners find that's not generous enough. This is often the case where an owner has lived in the same house for many years. Even in areas where the real estate market has softened somewhat, many sellers are still making a pretty penny on their sales.
Building on your basis
Basis, the IRS term for your home's value, begins with the amount you paid for your house. It includes settlement and closing costs and any debt. If you inherited the property, your basis is its fair market value on the day the previous owner died.
Home improvements that meet IRS guidelines can increase your home's basis. The tax agency says the property-related project must either materially add to the value of your home, considerably prolong its useful life or adapts it to new uses.
Common improvements that meet IRS specifications include putting a recreation room in your unfinished basement, adding another bathroom or bedroom putting up a fence, putting in new plumbing or wiring, installing a new roof and paving your driveway.
"If you replace all the flooring in a room, that's a capital expenditure," says Frederick M. Stein, RIA senior tax analyst from Thomson Tax & Accounting. "If you need to just replace some tiles, that's a repair. Anything that would require the old floor to be ripped out totally is a capital expenditure."
Similarly, thoroughly redoing a bathroom by taking out the old fixtures and putting in new ones or adding tiles to a wall that had been painted are capital upgrades that will add to the home's basis.
Projects that will add to your home's basis:
- Additions: Bedroom, bathroom, deck, garage, porch, patio
- Interior improvements: Built-in appliances, kitchen modernization, flooring, wall-to-wall carpeting
- Insulation: Attic, walls, floors, pipes and duct work
- Heating and air conditioning: Heating system, central air conditioning, furnace, duct work, central humidifier, filtration system.
- Plumbing: Septic system, water heater, soft water system, filtration system.
- Lawn and grounds: Landscaping, driveway, walkway, fence retaining wall, sprinkler system, swimming pool
- Miscellaneous: Storm windows and doors, new roof, central vacuum, wiring upgrades, satellite dish, security system
If you're a single home seller and your gain is s $250,000 or less, you owe no taxes. That exclusion amount is double for married homeowners who file a joint return. Also remember that to take this exclusion, you must have lived in the home for two of the last five years that you owned it.
Documenting the work
Any time you do make a major improvement to your home, be sure to file away all the associated paperwork. You'll need it when you do sell and have to figure your home's adjusted basis and how much profit you recognize on the sale.
"It could be years between the times you make those expenditures and when you need those records, that they become important," says Stein. |
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