By: Donna Fuscaldo
Article courtesy of Houselogic.com
track of the cost of capital improvements to your home can really pay off on
your tax return when it comes time to sell.
The tax break doesn't come
into play for everyone. Most home owners are exempted from paying taxes on the
first $250,000 of profit for single filers ($500,000 for joint filers). If you
move frequently, maybe it's not worth the effort to track capital improvement
expenses. But if you plan to live in your house a long time or make lots of
upgrades, saving receipts is a smart move.
What counts as a capital
While you may consider all the work you do to your home an
improvement, the IRS looks at things differently. A rule of thumb: A capital
improvement increases your home's value, while a non-eligible repair just
returns something to its original condition. According to the IRS, capital
improvements have to last for more than one year and add value to your home,
prolong its life, or adapt it to new uses.
Capital improvements can
include everything from a new bathroom or deck to a new water heater or furnace.
Page 9 of IRS Publication 523 has a list of eligible improvements. There are
limitations. The improvements must 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 can't count the carpeting as a capital improvement. Repairs,
like painting your house or fixing sagging gutters, don't count. The IRS
describes repairs as things that are done to maintain a home's good condition
without adding value or prolonging its life.
There can be a fine line
between a capital improvement and a repair, says Erik Lammert, tax research
specialist at the National Association of Tax Professionals. For instance, if
you replace a few shingles on your roof, it's a repair. If you replace the
entire roof, it's a capital improvement. Same goes for windows. If you replace a
broken window pane, repair. Put in a new window, capital improvement. One
exception: If your home is damaged in a fire or natural disaster, everything you
do to restore your home to its pre-loss condition counts as a capital
How capital improvements affect your gain
out how improvements affect your tax bill, you first have 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 the closing: fees to lawyers, survey
charges, transfer taxes, and home inspection, to name a few. You should be able
to find all those costs on the settlement statement you received at your
Next, you'll need to account for any subsequent capital
improvements you made to your home. Let's say you bought your home for $200,000
including all closing costs. That's the initial cost basis. You then spent
$25,000 to remodel your kitchen. Add those together and you get an adjusted cost
basis of $225,000.
Now, suppose you've 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 sell your home for
$475,000. That means you have a capital gain of $250,000 (the $475,000 sale
price minus the $225,000 cost basis). You're single, so you get an automatic
exemption for the $250,000 profit. End of story.
Here's where it gets
interesting. Had you not factored in the money you spent on the kitchen remodel,
you'd be facing a tax bill for that $25,000 gain that exceeded the automatic
exemption. By keeping receipts and adjusting your basis, you've saved about
$5,000 in taxes based on the 15% tax rate on capital gains. Well worth taking an
hour a month to organize your home-improvement receipts, don't you think?
For 2013, the top rate for most home sellers remains 15%. For sellers in the
new income tax bracket of 39.6%, the cap gains rate is 20%.
for these basis-busters
Some situations can lower your basis, thus
increasing your risk of facing a tax bill when you sell. Consult a tax adviser.
One common one: If you take depreciation on a home office, you have to subtract
those deductions from your basis. Any depreciation taken if you rented your
house works the same way. You also have to subtract subsidies from utility
companies for making energy-related home improvements or energy-efficiency tax
credits you've received. If you bought your home using the federal tax credit
for first-time homebuyers, you'll have to deduct that from your basis too, says
Mark Steber, chief tax officer at Jackson Hewitt Tax Services.
article provides general information about tax laws and consequences, but
shouldn’t be relied upon as tax or legal advice applicable to particular
transactions or circumstances. Consult a tax professional for such
for more articles like this.
2014 NATIONAL ASSOCIATION OF REALTORS®