What capital improvement tax benefits can you claim when you sell a property you bought as a home for yourself, an investment, or both? A lot, actually.
Adding together each capital improvement you made over the years can take a nice chunk off the cost basis of the real estate when you sell it. And that's a good thing, especially if they're substantial, like adding a bedroom, updating a kitchen, replacing the roof, finishing a basement, or swapping out to a whole new HVAC system.
Like anything tax-related, there are state and county differences, especially when it comes to tangible personal property, and there's more than one way to avoid the capital gains tax when selling a house. There are rules around rental properties, too, especially when it comes to the tax deduction and local property tax.
But for this piece, let's just consider the federal tax code. We also need to make clear the difference between a capital improvement and what's simply a repair. The former adds to the value; the latter simply restores something to its original condition.
Also, as this HouseLogic blog points out, "According to the IRS, capital improvements have to last for more than a year and add value to your home, prolong its life, or adapt it to new uses." That could be more living space for a growing family or permanent installation of accommodations for a resident with disabilities. And the improvements you're claiming as capital projects must still be obvious when you sell.
Soaring house prices could make the effort more worth it
Like a stock investment, the effect a capital improvement on a house has on your taxes depends on how long you hold it and how much you make. For instance, current tax law already exempts taxes on the profit from selling a home to the first $250,000 for single filers and $500,000 for joint filers.
But with home prices soaring again in many places, these could come into play, especially for investors whose timing, or luck, is really good, and it becomes worth it to include capital improvements in the cost basis of your sale.
In an example in that HouseLogic blog, a single filer who bought a house for $200,000 (including closing costs), put $25,000 into it, lived in it for two of the next five years, and sells it for $475,000 will save about $3,800 based on the 15% tax rate on capital gain that covers most taxpayers, except for those in the highest brackets.
The IRS provides the following as examples of things that can increase or decrease the basis in a house. It's from page 12 of Publication 530:
Increases to basis
Decreases to basis
- Putting an addition on your home
- Replacing an entire roof
- Paving your driveway
- Installing central air conditioning
- Rewiring your home
Assessments for local improvements
Amounts spent to restore damaged property
- Insurance or other reimbursement for casualty losses
- Deductible casualty loss not covered by insurance
- Payments received for easement or right-of-way granted
- Depreciation allowed or allowable if home is used for business or as a rental property
- Value of subsidy for energy conservation measure excluded from income
- Adoption tax benefits
But let's keep the focus here on capital improvements, a subcategory, but a big one, of what goes into determining the basis of your home when it's sold.
Source documents from the IRS
As for the IRS itself, two source documents for information on deducting capital improvements to a home are Publication 523: Selling Your Home and the aforementioned Publication 530: Tax Information for Homeowners.
In Publication 523, the "Improvements" section begins on page 8 with this: "Improvements add to the value of your home, prolong its useful life, or adapt it to new uses. You add the cost of additions and improvements to the basis of your property."
Then, on page 9, there's a list titled "Keep for Your Records" of the kinds of improvements the IRS considers acceptable for deducting from the cost basis of your home sale. They're broken into seven categories:
- Lawn and grounds
Within that are 39 specific items, such as a new roof, retaining wall, swimming pool, new siding, pipes and ductwork, built-in appliances, wall-to-wall carpeting, and even the lawn sprinkler system and a satellite dish.
The difference between routine repairs and remodeling
Publication 523 also makes that distinction between routine repairs and repairs done as part of a larger project by noting: "You can include repair-type work if it is done as part of an extensive remodeling or restoration job. For example, replacing broken windowpanes is a repair, but replacing the same window as part of a project of replacing all the windows in your home counts as an improvement."
In summary: The IRS says repairs done as part of larger projects do count as capital improvements if they're part of an extensive remodeling or restoration job.
Capital improvements you cannot include in your cost basis
That said, things like painting (inside or out), fixing leaks, and replacing broken hardware are considered necessary repairs and routine maintenance that don't add to the home's value or prolong its life, so no adding that to the basis.
Same with any improvements that are no longer part of the house. For instance, say you first installed a hardwood floor in a room and then carpeted over it later. You can add the cost of the carpeting but not what you paid for that initial finished floor.
Note: You cannot include any energy-related improvements, such as solar panels, for which you already received a tax credit. That goes for a bedroom addition to accommodate an adoption: If you already took the adoption credit, that's it.
How to keep track of it
The friendly folks at the IRS also have you covered there. There's a "Record of Home Improvements" on page 13 of Publication 530. Using that "Keep for Your Records" list from Publication 523 to guide what you put on the Publication 530 record-keeping form itself can help you. That's just a suggestion. It's hardly required. Create your own in Excel if you're so inclined.
"How you keep your records is up to you, but they must be clear and accurate and must be available to the IRS," we learn on page 12 in Publication 530.
But there's more. What's required, if the tax people do decide to check up on you, is to be able to provide proof you have all your ducks in a row. The list is a great start, but you need to provide receipts, canceled checks, and any similar evidence -- such as paid bills from a contractor -- of the improvements and additions to the basis of your real property.
How long to keep track of it
But for how long? That depends. Generally, the IRS says keep the proof of your capital projects until the period of limitations for that return runs out. That's the point after which the tax agency can no longer bring legal action, and it's usually for two or three years.
But for the cost basis on your property? "Keep those records as long as they are important in figuring the basis of the original or replacement property." That means for as long as you own the property, and then after you sell that property, for as long as the period of limitations applies to you, the IRS says.
But don't just take our word for it when it comes to the capital improvement tax break in the form of a deduction from your cost basis that you can legitimately claim. For your own research, be sure to use the latest tax bulletin, and always consult a tax professional if you have any uncertainty about what you're doing here.