Capital Improvements: When Are Your Home Renovations Tax Deductible?
February 12, 2024 6-minute read
Author: Miranda Crace
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.
See What You Qualify For
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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.
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 monthly payments.
Home Equity Line Of Credit (HELOC)
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 the equity you’ve built in your home. Instead of receiving cash like the cash-out refinance, you receive a line of credit. Rocket Mortgage® does not offer HELOCs at this time.
Both choices allow you to free up some money for certain expenses, including renovations, repairs and home improvements.
Quick Quiz: Which Scenarios Would Be Considered Capital Home Improvements?
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 qualifies as a capital home improvement.
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 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 (HOA) 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 project uses non-recurring capital expenditures to construct, develop and/or make improvements to public buildings, bridges, parks and transportation features.
These features may include 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 Help Your Home And Lower Your Taxes
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 speaking to a tax advisor.
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