What Home Improvements Are Tax Deductible When Selling?

When selling a home, the costs of certain improvements can reduce the tax owed on your profit. This benefit is not a typical annual deduction. Instead, the value of qualifying projects is factored into the calculation of the financial gain from the sale by increasing the home’s cost basis. The key is to distinguish between capital improvements and routine repairs.

Differentiating Capital Improvements from Repairs

A capital improvement is an expense that adds to the value of your home, prolongs its useful life, or adapts it to new uses. These are distinct from repairs, which are actions taken to maintain the property in its ordinary operating condition. A repair simply keeps the home as it was, while an improvement enhances it.

For example, constructing a new deck, adding a garage, or finishing a basement are all considered capital improvements. Other qualifying projects include a complete kitchen or bathroom remodel, installing a new HVAC system, or replacing all of the windows. Paving a driveway for the first time or adding significant landscaping features also qualify as they enhance the property’s value.

In contrast, repairs include tasks like repainting a single room or fixing a leaky faucet. Replacing a single broken window pane, patching a small area of a roof, or having an appliance serviced are also classified as repairs. These actions restore the property to its previous state, and their costs cannot be added to the home’s cost basis.

The context of the work performed can influence its classification. For instance, if painting is done as part of a larger renovation project, such as a full kitchen remodel, its cost can be included as part of the total capital improvement. In this scenario, the painting is integral to the overall enhancement of the property.

Calculating Your Home’s Adjusted Cost Basis

The tax benefit of home improvements is realized by increasing your property’s adjusted cost basis. This figure is a component in determining the profit made from a sale. The starting point for this calculation is the home’s original cost basis, which is the price you paid to acquire the property.

To calculate the adjusted cost basis, you begin with the original purchase price and add certain settlement fees and closing costs from the purchase. These can include expenses detailed in your original settlement statement, such as:

• Title insurance
• Legal fees
• Recording fees
• Abstract fees

Next, you add the total cost of all qualifying capital improvements made during your ownership. For example, if you purchased a home for $300,000 and paid $5,000 in closing costs, your initial basis is $305,000. If you later spent $40,000 on a qualifying kitchen remodel, your adjusted cost basis would increase to $345,000.

A final consideration is any depreciation you may have claimed. If you ever used a portion of your home for business purposes or rented it out, you may have taken depreciation deductions. These deductions must be subtracted from your cost basis. For example, if you had claimed $10,000 in depreciation, your adjusted cost basis would be reduced to $335,000.

Determining Your Taxable Gain

Once the adjusted cost basis is established, it is used to calculate the total gain on the sale. The first step is to determine the “amount realized” from the sale. This is calculated by taking the final selling price and subtracting selling expenses, such as real estate agent commissions and legal fees.

The total capital gain is then found by subtracting your adjusted cost basis from the amount realized. For instance, if you sold your home for $500,000 and had $30,000 in selling expenses, the amount realized would be $470,000. Using the adjusted cost basis of $345,000, the total capital gain would be $125,000 ($470,000 – $345,000).

Many homeowners can exclude this gain from their income under Section 121 of the tax code. Single filers can exclude up to $250,000 of gain, and married couples filing jointly can exclude up to $500,000. To qualify, you must meet both the ownership and use tests. This requires you to have owned the home and lived in it as your primary residence for at least two of the five years leading up to the sale.

Applying this exclusion determines your final taxable gain. In the ongoing example, the $125,000 capital gain is below the exclusion thresholds. Therefore, the entire gain would be excluded from income, resulting in no federal tax on the sale. If the gain had exceeded the exclusion amount, only the excess amount would be subject to capital gains tax.

Documentation and Reporting Requirements

Maintaining thorough records is necessary to substantiate your adjusted cost basis. Homeowners should keep all documents related to the purchase, sale, and improvement of their property. This includes the closing statements from both the purchase and the final sale. For all capital improvements, it is important to retain receipts, invoices, contracts, and proof of payment.

If you have a taxable gain, you will need to file Form 8949, Sales and Other Dispositions of Capital Assets, and Schedule D, Capital Gains and Losses. On Form 8949, you will report the home’s selling price, your original cost basis, and the adjustments for closing costs and capital improvements. This information is then carried over to Schedule D.

If the entire gain from the sale is excludable, you may not need to report the sale on your tax return. An exception occurs if you receive a Form 1099-S, Proceeds From Real Estate Transactions. The issuance of this form requires you to report the sale, even if no tax is ultimately due.