Capital Improvements: When Are Your Home Renovations Tax Deductible?

A modern, updated home is appealing to many buyers. But what do these home renovation costs look like to the seller? If you’re thinking about remodeling your home to increase its value, you might be wondering about the financial implications that could have. Capital home improvements are renovations you can make that not only bring up your home’s value but are also tax-deductible.

Read on to find out what constitutes a capital improvement and how they could help you during your resale process.

What Is A Capital Improvement?

A capital improvement is a permanent structural alteration or repair to a property that improves it substantially, thereby increasing the overall home value. Capital improvements may involve updating the property to suit new needs or extending the life of the home. However, basic maintenance and repairs aren’t considered capital improvements.

Documenting the capital improvements you implement into your home – such as a renovation or remodel – can help lower your tax payments. These structural changes are typically exempt from sales taxes and can help homeowners avoid paying the capital gains tax when they sell the property.

What Does Cost Basis Mean And How Does It Relate To Capital Improvements?

Cost basis is the original purchasing price of an asset (like property or an investment) plus any closing costs paid by the buyer and the cost of home improvements. Sometimes called tax basis, the cost basis is adjusted for certain factors, like depreciation.

You can increase the cost basis of your home with a capital home improvement, but the Internal Revenue Service (IRS) defines the standards for improvements that qualify for an increase in cost basis. Typically, you must make sure the improvement:

• Is a permanent fixture of the home
• Is a desirable feature
• Increases the home’s value

While small repairs and home maintenance are not generally considered capital improvements, they may be if the repairs are a part of a larger project. For example, painting a home’s interior is not typically a capital improvement; however, repainting after a fire as part of the repair might be considered one.

Other times when a repair might not qualify as a capital home improvement are:

• Repairs with a useful life of less than a year
• Any repairs necessary to maintenance that don’t improve the home’s value
• Repairs or improvements that are no longer in the home (such as replaced carpeting)

You can see other accepted capital improvements on the IRS’s 523 publication.

What Is Considered A Capital Improvement?

Let’s look at two examples of capital improvements that may qualify as a tax deduction.

Capital Improvements That Increase Cost Basis

Renovations or repairs that increase the cost basis of your home may qualify as capital improvements. One project that may be considered a capital improvement (that increases your cost basis) is installing a central air conditioning system in your home.

Constructing a desirable, permanent fixture to the property, such as an enclosed garage or screened-in front porch, might also qualify as a capital improvement.

Capital improvements that increase cost basis may also qualify for a capital gains tax exemption. We’ll get to that later on in the article.

Capital Improvements For Medical Purposes

Another type of capital improvement that can be considered for a tax deduction is a renovation or addition made for medical purposes. You can upgrade or renovate aspects of the house to support the medical welfare of you, your spouse or your dependents.

Any permanent home improvements in this category can be included as medical expenses, which are exempt from taxes. Some examples of home renovations made for medical purposes include:

• Installing handrails and accessibility ramps
• Widening or modifying entrances, exits, doorways and hallways
• Adding railings and support bars to bathrooms
• Installing lifts on stairways and/or porches
• Relocating or modifying electrical outlets in the home

What Is The Capital Gains Tax Exemption?

The capital gains tax typically applies whenever you sell an asset for more than its original purchase price. So, if you originally bought your house for $200,000 and sold it for $300,000, your capital gain is $100,000. The amount you made in profit is subject to the capital gains tax.

However, the IRS offers a tax exemption from the capital gains tax when you sell your primary residence. In order to qualify for the tax exemption, homeowners must have owned and used their house as a primary residence for at least 2 out of the 5 years before selling the property.

If you’re a single taxpayer, you may be exempt from paying the capital gains tax on the first $250,000 you make in profit from the home sale. If you’re married filing jointly, you may be able to avoid paying the tax on a gain of up to $500,000 made from the real estate transaction.

When you increase your cost basis, you can also reduce your capital gains tax. That’s because you calculate your gain after you subtract the new cost basis from the profit of selling your home. Since the gain is smaller, the applied taxes are as well.

How Do Homeowners Finance Capital Improvements?

Homeowners have several options when deciding how to pay for capital improvements. Let’s go over some of the more common financing options.

Cash-Out Refinance

One popular example of financing a capital home improvement is a cash-out refinance, which is a type of mortgage refinancing that uses the amount of equity you’ve built up in your home. In essence, you borrow more on your original mortgage and accept the difference as cash which you can use on improvements.

You then pay off your original mortgage first, followed by the second mortgage – they don’t stack together as