Capital Improvements: When Are Your Home Upgrades Worth A Tax Break?
Ashley Kilroy3-minute read
April 26, 2021
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 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.
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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 the improvement a permanent fixture of the home, and it has to be a desirable feature. Overall, the change has to heighten the home’s value. While small repairs or maintenance are not generally included, they may be if they are 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 where a repair might not be included are: Those with a lifespan of less than a year, any necessary to maintenance but don’t improve the home’s value, and costs for 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.
Capital Improvement Examples
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 are handrails and ramps.
Another exemption is a 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 this 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 calculated 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 and have other uses like consolidating debt at a lower interest rate.
Quick Quiz: Can You Identify Which Would Be Considered Capital Improvements On A Home?
Let’s test your knowledge to see if you understand 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 windowpanes.
Example 2: You have a new septic system installed.
Example 3: You had wall-to-wall carpeting put in, but you later replace 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.
Answer 1: No
Answer 2: Yes
Answer 3: No
Answer 4: Yes
Answer 5: Yes
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 are considering the resale of your home, it might be worth looking into. Some may need a cash-out refinance to accomplish that, though. If so, you may want to learn the tax implications involved and explore other possible impacts on your home updating process through our Learning Center.
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