Determining Home Improvement Costs for Taxes

By Kim Ciccarelli Kantor CFP®, CAP®

At times homeownership can seem like driving down a winding road at night–difficult to navigate without some guiding light to lead the way. There are many different books, pamphlets, and articles available covering the subject of home ownership. However, trying to weed through every iota of information on the topic would prove a tremendous undertaking. One topic we have received various questions about pertains to keeping track of home improvements.

“What home improvements should I keep track of?”

“Can they be deducted from my taxes?”

“Is there any future financial benefit beyond possibly increasing the value of my home?”

To shed some “guiding light” on this often essential side of home ownership, we first need to look at the basis of your property.

What is “basis”?

Generally, the basis of an asset is the cost to you. In regards to real estate, it is the amount of your capital investment in property for tax purposes. Your starting basis is what you paid for the home if you purchased it or built it. When you go through the process of purchasing the property, other costs may arise. Some of these costs can be added onto the basis. Settlement and closing costs that you may be able to include in the basis are:

• Abstract fees
• Charges for installing utility services
• Legal and accounting fees
• Survey fees
• Recording fees
• Transfer or stamp taxes
• Owner’s title insurance
• Real estate taxes assumed from seller

If you receive inherited or gifted property and did not technically “purchase” the property, you will still have a basis. The rules for determining it are slightly different. Inherited property can typically be “stepped up” to the fair market value, as appraised, for the property on the date of the decedent’s death. The basis for gifted property typically does not receive a “step up” in value, but retains the cost basis from the original purchaser.

Much like your home, your basis may undergo some “renovations” over time. The starting basis of your home changes to reflect the true cost of your investment. This is your adjusted basis. If you live in a home for years, make improvements and/or additions to the property, the cost of those changes could be added to the basis (if they qualify under the IRS’s guidelines).   

When your property is sold you subtract the adjusted basis from the selling price to determine your profit or loss. This also determines your potential tax liability. As of 2019, if you have lived in your residence for at least two of the last five years, you could keep $250,000 in profits tax-free. For married couples filing jointly, that amount is doubled to $500,000. For property owned less than a year, you are typically taxed at your regular tax rate. Some exceptions do exist, such as if you become disabled or have to sell the home because of a job relocation.

Any profits made over the previously stated amounts may be subject to capital gains taxes. Capital gains taxes are taxes on the profits from the sale of a specific type of asset, such as real estate. The tax is only owed after the asset is sold, not while it is owned. An asset could be held for years, continue to appreciate, and potentially incur substantial tax liabilities without proper planning. Since a higher basis typically means less tax liability, it would be beneficial to assess various expenditures made on your property to determine if they may qualify as an IRS approved improvement.

In recent years, property value has been largely in favor of sellers. As we saw with the housing boom in Silicon Valley, a significant brisk increase in real estate value in an area is possible. If you purchased the home over a decade ago, the inflation of real estate prices could very likely put you over a $250,000 profit. The cost of even just one home improvement could potentially increase your basis by a couple figures. Improvements that can be factored into your adjusted basis include:

• Additional bedrooms, bathrooms, a deck, garage, porch or patio
• Landscaping, a driveway, walkway, fence, retaining wall, or a swimming pool
• Storm windows or doors
• A new roof, siding, or satellite dish
• A heating system
• Central air conditioning
• Central humidifier or vacuum
• Air or water filtration system
• Security system or lawn sprinkler system

It is important to note that regular repairs to the property do not count toward the basis. An improvement adds value to the home, prolongs its useful life, or adapts it to new uses. A repair is necessary maintenance to keep the property habitable and in working condition. In general, if you are adding a new item or upgrading an existing item, it is an improvement. For those considering refreshing their kitchen with some new stainless steel appliances, rejoice!

Whether property has been individually purchased, inherited or gifted, it is important to keep track of any costs which could affect the basis. Most longtime home owners know the importance of keeping track of all home supporting documentation. If there is a disaster, casualty or theft loss, you will need the files to replace or obtain reimbursement for the items. Keeping records of home improvements should follow suit. The IRS recommends that you keep tax returns and any supporting paperwork for at least three years post the return. They can also ask for records up to six years after filing if they suspect someone failed to report twenty five percent or more of their gross income. All receipts or invoices pertaining to the cost of home improvements should also be kept until 6 years after the sale of your home.

Home ownership may bring with it a host of questions, but our team is here to help you navigate the road.