What home improvements are tax deductible?

What is a capital improvement?

The IRS defines a capital improvement as an improvement that:

• Adds to the value of your home
• Prolongs the useful life of your home
• Adapts your home to new uses

A capital improvement is tax deductible, but only if it exists for more than one year and still exists when you sell the house. For instance, if you put in wall-to-wall carpeting a year after you purchase your home and then replace the carpet with hardwood floors five years later, you can’t include the carpeting as a capital improvement when you sell your home.

What qualifies as a capital improvement?

A capital improvement is different from a regular repair. Repair work or maintenance fixes existing damage or prevents deterioration. When you maintain your property, you simply return it to its baseline condition. For instance, if you paint your bedroom or replace a window, these are considered repairs, not capital improvements.

A capital improvement enhances the home or increases the value of the property. Capital improvements are typically more extensive — and expensive — than repairs.

The IRS outlines many examples of what qualifies as a capital improvement. These include:

• Additions: adding a bathroom, garage, deck or patio
• Lawn and grounds: doing landscaping or adding a driveway, swimming pool or fence
• Exterior: installing a new room, new siding, storm windows or a home security system
• Insulation: insulating the attic, walls, floors or pipes
• Systems: adding central air conditioning, ductwork or a lawn sprinkler system
• Plumbing: installing a septic system, water heater or filtration system
• Interior: adding new built-in appliances or a fireplace or remodeling the kitchen

Examples of repairs that do not qualify as capital improvements include:

• Painting
• Fixing leaks
• Fixing holes or cracks
• Replacing broken hardware
• Any improvements with a life expectancy of less than one year

While repairs typically don’t count as capital improvements, you can include repairs in some cases when they’re part of a larger home remodeling project. For instance, replacing a broken window isn’t considered a capital improvement. However, replacing all of the windows in your home, including the broken window, counts as a capital improvement.

Can I deduct costs for capital improvements?

All qualifying capital improvements are tax deductible. However, you can’t claim the deduction until you sell the home. When you’re ready to sell, you can add the cost of any capital improvements to your property’s cost basis.

Cost basis is the original value you paid for an asset, including fees and other expenses. For property, the cost basis is the purchase price. Certain events may require you to increase or decrease the cost basis. These are known as basis adjustments. For instance, if you make capital improvements to your property, this can increase your cost basis.

When you sell your home, the profit from the sale is subject to capital gains taxes. However, if you’ve made capital improvements to the property, it can increase the cost basis and decrease the amount you owe in capital gain taxes.

For instance, let’s say you purchase a property for $300,000. You make $50,000 in capital improvements. You then sell your home for $500,000 after living there for 10 years.

Gains in profit (taxable amount) = sale price - (purchase price + capital improvements)

Instead of paying taxes on capital gains of $200,000 (sale price of $500,000 minus purchase price of $300,000 equals $200,000), you will only have to pay taxes on capital gains of $150,000.

Capital gains taxes range from 0% to 20%, depending on factors like your income and how long you’ve owned the property.

There are additional variables to consider when you’re selling your home. For instance, if you’ve lived in your house for at least two of the five years preceding the sale, you don’t have to pay taxes on the first $250,000 of profit. Married couples don’t have to pay taxes on the first $500,000 of profit.

In these cases, if your home’s selling price is less than the excluded amount, a capital improvement deduction might not affect how much you owe.

Tracking costs for capital improvements

If you purchase a home and make capital improvements, keep track of all costs. This includes receipts, purchase orders and any other documents you receive.

Logan Allec, a certified public accountant and the founder of Choice Tax Relief, advises homeowners to keep all receipts and invoices from contractors. He recommends storing these records digitally as well as tracking costs on a spreadsheet. That way, even if the documents are no longer legible when you need them, you can cross-reference the details on the spreadsheet.

Bottom line

Home improvements that qualify as capital improvements are tax deductible, but not until you sell your home. Before you start a huge home renovation project, make sure you know what constitutes a capital gain versus a repair, as many repairs are not deductible.

While capital improvement deductions can help people with gains above the capital gains exclusion, they won’t benefit all homeowners. Speaking to a tax professional can help you better understand how capital improvements may affect your tax situation.