In the United States, certain “qualified” home improvements may reduce your tax bite when it's time to sell your house and some could allow you to take an immediate tax credit, but some of those same improvements could also raise your property tax bill by triggering a reassessment of your property's value.
Fortunately, a property tax increase caused by a home improvement is typically outweighed by your increase in equity, higher resale value and possibly a reduced tax bite – not to mention your enjoyment of the improvements.
Capital improvements are those home improvements that may ultimately help reduce your taxes.
Qualifying improvements are improvements that increase your home's overall value or prolong the life of the structure. That includes: insulation, new heating and/or cooling systems, a fence, a driveway, adding a garage or carport, adding a new room(s), additions, a swimming pool, landscaping, a porch or a deck, built-in appliances, a new roof, etc.
Repairs, maintenance and upkeep typically don't qualify as a capital improvements. These include such things as: plastering, painting, wallpapering, replacing broken or cracked tiles, fixing minor leaks, patching your roof, repairing broken windows, and so on.
The moral of the story is; whenever possible, replace instead of repairing because capital improvements increase the homeowner's cost basis in the residence and may reduce taxes.
(To get more information about what is considered a capital improvement see U.S. Internal Revenue Service Publication 523 “Selling Your Home” and the publication's correction, “Notice 1221.”)
Your Cost Basis
The cost basis of your home is used in the calculation to figure your capital gains tax. It isn't as simple as subtracting the sale price from the purchase price.
You first start with the original purchase price, add your closing costs, add any fees for title insurance and/or legal services, and the like. Loan acquisition costs cannot be included. Then add the cost of “qualified” home improvements.
Any insurance proceeds received for theft, storm damage, and other casualty losses would be subtracted, then any costs to rebuild or replace would be added back. You also must subtract any deferred gain from previously owned houses and subtract allowed depreciation for any portion of the property that was used and claimed for business purposes. The net result is your new or adjusted cost basis.
To determine the taxes, subtract the adjusted cost basis from the sales price, as well as selling costs (real estate commissions, legal fees, etc.).
Provided they are completed within 90 days of your sale and provided they were completed to make the home more saleable items otherwise considered repairs (such as wallpapering, painting, planting flowers, maintenance, etc.) can also be classified as selling costs. So from a tax perspective this is a good time to perform those repairs.
The difference between the adjusted cost basis and the sales price is your capital gain of which $250,000 ($500,000 for joint filers) is currently excluded from taxes.
Home Energy Efficiency Improvement Tax Credits
Consumers who purchase and install specific products in the home, such as windows that are energy-efficient, roofs, insulation, doors, and heating and cooling equipment can receive a tax credit of up to $500 beginning January 2006.
The legislation providing these credits, known as EPACT, also provides a credit equal to 30% of qualifying expenditures for the purchase of qualified photovoltaic property and for solar water heating property used exclusively for purposes other than heating swimming pools and hot tubs. The maximum credit is $2000.
Improvements must be installed in or on the taxpayer's principal residence in the United States. Home improvement tax credits apply for improvements made between January 1, 2006 and December 31, 2007. Recently, a bill has been submitted to extend this program.
As always, check with your accountant to see how these regulations and any new changes in the code may affect you.