There is no question that there are far less people today that have the kind of equity in their home that they did five to ten years ago. In most areas across the country Real Estate values have dropped by a substantial margin decreasing the amount of folks who have capital gains concerns.
One of the great benefits of home ownership has been the fact that equity growth to an extent does not always get taxed.
A very important capital gains tax law went into effect in 1997 and is known as the Taxpayer Relief Act of 1997.
The current Real Estate capital gains tax law when selling your personal residence allows for an exclusion of up to $250,000 in profit if you are single and $500,000 if you are married. In order to be eligible for the tax exclusion you must have lived in your home for two of the last five years. The home must also be your personal residence and can not be considered an investment property.
If you move often or do not have substantial equity in your property then tax breaks on home improvements are not going to be much of a concern.
For those that are fortunate enough to have lived in their home for a long period of time and have built up a sizable equity position, there is good reason to keep track of what you have spent on home improvements.
By keeping track of the home improvements that have taken place in your property you are able to increase the cost basis which will decrease the amount of taxes you pay when it comes time to sell.
How do home improvement tax breaks work?
In order to figure out how to calculate your tax break from home improvements you are going to need to figure out what your initial cost basis was when you 1st purchased your home.
This will be what you actually paid plus any closing costs such as attorney fees, transfer taxes, surveys, commissions or any inspection related charges.
You will then need to figure out all the home improvements you have made to your home since the purchase. As an example lets say you purchased your home for $400,000 including all the closing cost expenses.
Lets further assume you also have $50,000 in home improvements since you purchased including a new bath room, a finished basement, a large deck and brick patio. if you add the purchase price and improvement costs together you get an adjusted basis of $450,000.
Going back to the qualifications of the capital gains tax law for Real Estate outlined above, lets assume you have met the litmus test and have lived in the home for two out of the last five years as your primary residence.
You find out you are going to be moving out of the area you are located in and sell your home for $700,000. If you are single the tax law says you can exclude up to $250,000 in profit or gain. Using the $700,000 sale price minus the adjusted cost basis of $450,000. You would not pay any taxes on the sale.
Here is where the tax breaks on home improvements come in. If you had not kept track of what you spent making your home better you would be paying taxes on $50,000 because that would be become what is considered profit to the IRS.
By keeping receipts on the home improvement dollars you have invested you will save $7500 0n your taxes! As of this writing the current capital gains tax rate is 15%. $50,000 x 15% = $7500. This is obviously a nice chunk of change to save just by being a little studious.
What counts as a home improvement for tax purposes?
When calculating tax breaks the one thing you don't want to do is fool around with the IRS. While you may consider every dollar you spend on your home an improvement the IRS certainly does NOT! As a matter of fact most Realtors or buyers won't either. See home improvements with the worst ROI.
According to the IRS an improvement increases the value of your home while a non-eligible repair just returns something back to it's original condition. The IRS further states that a capital improvement has to last for more than one year, add value to your home or prolong it's life.
Home improvements must also be there when you sell your home as well. For example if you spent money putting tile flooring down in your kitchen fifteen years ago and then five years ago put in new hardwood floors you can't claim both as improvements.
It is important to note that repairs do not count as improvements. Again according to the IRS, repairs are things that are done to keep up a homes condition without adding value or prolonging it's life. There are real slight differences in comparing an improvement to a repair. An example of a repair would be fixing a window pain. An improvement would be replacing a window.
If you are unsure on whether an improvement you have made to your home can be counted or not I would recommend speaking to a qualified tax professional or look at page 9 of publication 523 which details tax issues when selling a home.
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About the Author: The above Real Estate information on home improvement tax deductions was provided by Bill Gassett, a Nationally recognized leader in his field. Bill can be reached via email at firstname.lastname@example.org or by phone at 508-435-5356.
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