Capital Improvements: When Are Your Home Upgrades Worth A Tax Break?
Miranda Crace5-minute read
January 06, 2023
An updated home is an appealing home to many buyers. But what are the expenses for the home seller? If you are beginning to consider 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 value but are 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 its overall value. That may come with updating the property to suit new needs or extending its life. However, basic maintenance and repair are not considered capital improvements.
Documenting the capital improvements you implement into your home – such as a renovation or remodel – can help lower tax payments, since these changes are typically sales tax-exempt 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. Sometimes called tax basis, it’s essentially the price you paid for your house and adjusted for certain factors like depreciation.
You can increase the cost basis of your home with a capital home improvement, but the IRS defines the standards. 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 or maintenance are not generally included, they may be if they’re a part of a larger project. For example, painting the interior is not typically a capital improvement; however, repainting after a fire as part of the repair might be.
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 but 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 For Medical Purposes
One type of a capital improvement that can be considered for a tax deduction is a change made for medical purposes. You can alter the home to support the medical welfare of you, your spouse, or your children. Any permanent home improvements in this category can be included as a medical expense, which is tax exempt. Some examples include handrails and ramps.
Capital Improvements That Increase Cost Basis
As previously mentioned, renovations or repairs that increase the cost basis of your home may qualify as capital improvements. Examples of such capital improvements may include installing a central air conditioning system in your home or constructing a desirable, permanent fixture to the property, such as an enclosed garage or screened-in front porch.
Capital improvements that increase cost basis may also qualify for a capital gains tax exemption, which we’ll discuss in the next section.
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. The IRS offers a tax exemption from the capital gains tax when your primary home resale matches certain specifications.
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 People Finance Capital Home Improvements?
One popular example is cash-out refinances, 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 the original first followed by the second mortgage – they don’t stack together as monthly payments.
Another option is a home equity line of credit (HELOC). This method also uses your home’s equity to help finance your capital improvement. Here, you borrow money against built-up equity, but instead of receiving cash like the cash-out refinance, you receive a line of credit. Rocket Mortgage® does not offer HELOCs.
Both choices let you free up some money for certain expenses, including renovations, repairs or other home improvements.
Quick Quiz: Can You Identify Which Would Be Considered Capital Improvements On A Home?
Let’s review your understanding of capital improvements.
Which Of The Following Qualify As Capital Improvements?
Answer “yes” or “no” as to whether each of these examples qualify.
Example 1: Your windows are all the same age when one breaks. You only replace a few window panes.
Example 2: You have a new septic system installed.
Example 3: You had wall-to-wall carpeting put in, but you later removed it.
Example 4: You built a new porch onto the front of the house.
Example 5: You put up a new coat of paint after your interior flooded.
Now compare your responses to the correct answers below.
Answer 1: No. Replacing a few panes will not increase the home’s value. This qualifies only as maintenance.
Answer 2: Yes. This is a major change to the value and structure of your home.
Answer 3: No. Since the carpeting you installed is gone, it cannot qualify as an improvement to the home.
Answer 4: Yes. This is a major change to the value and structure of your home.
Answer 5: Yes. While painting your home typically does not qualify, it can if it is after a fire or flood.
Capital Improvement FAQs
Now that we’ve explored the basics of capital home improvements, let’s take a look at some frequently asked questions.
What is a capital improvement fee?
When a home or unit is sold in an HOA community, the Homeowners Association charges a one-time capital improvement fee. This fee – which is typically a small percentage of the sales price or a specific dollar amount – helps fund capital improvements within the community.
What is a capital improvement plan?
A capital improvement plan is usually a multi-year project to plan and fund capital improvements to the infrastructure of a city or community. Also called a capital improvement program (CIP), a capital improvement project uses non-recurring capital expenditures to construct, develop and/or make improvements to public buildings, bridges, parks and transportation features such as roads, sidewalks, bike lanes, bus stops and subway platforms.
What is a certificate of capital improvement?
A certificate of capital improvement is a form that a property owner or other customer gives a contractor or project manager to certify that the project qualifies as a capital improvement and that no sales tax should be collected.
The Bottom Line: Capital Improvements Don’t Just Help Your Home; They Lower Your Taxes, Too
While not all home repairs or maintenance can save you money, capital home improvements provide a tax-deductible option. While they have parameters, there are several ways to implement them and benefit from tax-exempt opportunities. If you’re considering the resale of your home, it might be worth looking into.
One way to finance a capital improvement project is by tapping into your home’s equity with a cash-out refinance. Start a mortgage application to see how much you qualify for.
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