We consulted CPAs and dug into IRS paperwork to clear up misperceptions around home improvement tax deductions and shed light on a few lesser-known tax breaks. —-
2020 was a big year for consumer remodeling. Since the pandemic began, 76% of real estate agents reported that renovation activity was on the rise in their market. As late as November, Home Depot sales surged 23.2%, exceeding the company’s performance forecasts across the board.
With tax season right around the corner, many homeowners are wondering: Can I write off the costs of my expensive bathroom remodel, patio addition, or kitchen upgrade?
We hate to disappoint, but “the vast majority of home improvements won’t qualify for deductions,” says Stephanie Ng, CPA and author of How to Pass the CPA Exam. The truth hurts, but it’s better to know the tax code than assume your pandemic renovation spree will help you save big on what you owe to Uncle Sam.
In this guide, we consulted CPAs and dug into IRS paperwork to clear up misperceptions around home improvement tax deductions and shed light on a few lesser-known tax breaks you just might qualify for as a homeowner.
How capital improvements work
Let’s be clear: the cost of your new shower or roof repair won’t directly reduce your income taxes. Confusion arises over online reports that may erroneously refer to dated federal IRS code that allowed home sellers to deduct “fixing-up” expenses, such as “the costs of painting the home, planting flowers, and replacing broken windows” completed in the 90 days prior to closing on their home for resale.
That tax break no longer exists.
While you can’t write off home improvements as an item on your income tax return, certain home renovations will qualify as “capital improvements.” Capital improvements can save you from paying more in capital gains when the time comes to sell your home. So even if you didn’t sell your home during the previous tax year, you should still keep track of receipts for any major projects for whenever that time comes.
Capital gains on your primary home, explained
When you sell a capital asset like real estate, the government typically wants a piece of the profits. However, as an incentive encouraging homeownership, you can exclude up to $250,000 of profit on the sale when filing taxes as an individual — so long as you’ve lived in it and owned it for at least two of the past five years. Taxpayers who file a joint return with a spouse can exclude up to $500,000 of that gain. In either case, if your gain doesn’t exceed the maximum limit, you likely won’t need to report the home sale on your tax return.
Capital gains are calculated by taking the sale price of your home minus its adjusted cost basis. Adjust cost basis is a fancy way of saying the original value of the home (i.e., what you paid for it at the time of purchase) plus the cost of any qualifying capital improvements and selling fees like agent commissions.
Capital improvements and your cost basis
Still with us? Here’s where capital improvements come into play.
Let’s say you bought your house for $250,000 but spent $30,000 to improve it. Years later you sell it for $525,000 in a fast-appreciating market.
You’d calculate your capital gains as follows:
$525,000 (sale price)
$280,000 ($250,000 original price + $30,000 in improvements — for simplifying purposes we’re going to leave out selling fees)
= a capital gain of $245,000
In this case, the $30,000 capital improvement reduced your taxable gain from $275,000 ($525,000 – $250,000, no renovation included) to $245,000 with the improvement factored in.
For a single filer, that’s significant. You just went from having to pay taxes on $25,000 worth of gain, to not needing to report the sale at all because the gain falls below the $250,000 exclusion cap.
Without the improvement, you would need to pay long-term capital gains tax of 0%, 15%, or 20% depending on your income bracket on that extra $25,000, assuming you’ve owned the house for more than a year. If you’ve owned the house for less than a year, the gain would be taxed as regular income.
Capital improvements vs. repairs
The trick is that you can’t assume any old plumbing repair will constitute an improvement. As defined by the IRS, a capital improvement has to increase the home’s value, alter its uses, or materially extend its useful life. If you’re fixing something that’s broken, that’s usually considered basic maintenance and it will not qualify as a tax deduction, unless you’re using the home as an investment property. For more on deducting repairs and improvements as a rental property owner, visit IRS Publication 527.
According to IRS Publication 523 on Selling Your Home, capital improvements include:
- Home additions: adding onto a home’s bedroom, bathroom, deck, garage, porch, or patio
- Lawn and grounds: landscaping, driveway work, walkway improvements, fences, retaining walls, or a swimming pool
- Exterior: a new room, siding, storm windows/doors, or even a new satellite dish
- Insulation: adding insulation to the attic, walls, floors, or ducts
- Systems: adding or completely replacing HVAC systems, a furnace, duct work, central humidifier, central vacuum, air or water filtration systems, new wiring, security systems, or lawn sprinkler systems
- Plumbing: improvements to the septic system, water heater, soft water system, or the water filtration system
- Interior: installing built-in appliances, modernizing the kitchen, new flooring, carpeting, or a fireplace.
You can consult our guide on capital improvements vs. repairs for a better idea of which projects offer any tax benefits. But before undertaking any project that you think will add to your cost basis, double check that it qualifies as an improvement by consulting a trusted tax professional.
Keep those home improvement receipts for when you sell
If you’re relying on home improvements to add to your home’s basis and reduce potential gain due at the sale of your home, you’ll need to keep a thorough record of receipts and bills around the projects. That’s generally a good practice anyway, says Amanda Jones, a San Francisco real estate agent with nearly 20 years of experience under her belt.
“Keeping receipts isn’t just good for taxes,” Jones explains. “In many cases, you need to provide them as part of disclosures. A lot of the California disclosures ask you to attach receipts, plans, anything that you have done regarding your home or renovations.”
Records that help determine your cost basis include invoices from contractors, sales receipts from DIY projects, and permitting costs associated with each improvement.
Renovations for medical purposes
If you, your spouse, or a dependent requires renovations to your home for medical purposes, you have an opportunity to write-off the cost of those projects per the capital expenses Publication 502 of the IRS tax code. These improvements would fall under medical expenses, not home improvement expenses, and could include anything from permanent renovations to the cost of installing medical equipment.
However, if the renovation does add value to your home, deductions can get complicated, says Ng. Let’s say you renovated your kitchen cabinets and had them lowered to improve accessibility. The project costs $20,000 and would add $8,000 to your home’s value. In that case, the remaining $12,000 could be deducted as a medical expense.
Being able to take advantage of this deduction does have a significant barrier to entry, Ng explains. You have to itemize your annual tax return to get this benefit, but because of the Tax Cuts and Jobs Act (TCJA) it’s much harder to exceed the standard deduction than it once was.
Adding to the complexity, you can only deduct the medical expenses that exceed 7.5% of your Adjusted Gross Income (AGI). “Meeting all of these criteria is nearly impossible for the vast majority of taxpayers,” Ng says.
Moving expenses for the military
If you’re moving and in the military, you may be able to write-off your moving and relocation expenses that are not already reimbursed. However, according to the IRS, the move must be a permanent change of station under the following circumstances:
- The move to your first active duty post
- A move from one post to another
- The move from your last post to a home within the U.S. This move must occur within a year of you ending active duty.
According to Publication 3 of the IRS, active military members can deducting the following costs associated with moving:
- Travel: lodging, airfare, and driving expenses (gas, tolls, and oil)
- Moving items: costs associated with trailer rental, professional moving services, packing, and insurance as well as the costs of storage for up to 30 days after your move
While active military personnel can write-off costs associated with their move, Ng cautions that you “can only count reasonable costs.” That means lavish hotel stays or over the top white glove moving services may be excluded. In addition, most moving expenses are covered by authorized military allowances anyway which may render the tax break useless.
Space used as a home office (self-employed only)
It’s estimated that 30% of the workforce will work from home in 2021, piquing curiosity around home office tax deductions. However, according to the IRS, only those who are self-employed and conduct the majority of their business out the room may qualify for a home office deduction. The TCJA eliminated the ability for remote workers who work under an employer to claim this deduction.
If you qualify for the deduction, you can calculate the write-off in one of two ways:
With this method, you can deduct certain non-deductible house expenses as business write-offs based on the percentage of the home used exclusively as office space. So if you have a 100 square foot office in a 1,000 square foot home, your office accounts for 10% of your home. That means you can deduct 10% of annual cost of your utilities, HOA fees, and homeowners insurance and the like.
You can also deduct costs as direct expenses. Let’s say you decide to repaint your office a fresh shade of greige — you can deduct the total cost of the expense to buy the paint supplies and any other costs associated with completing the project. You can also deduct the costs of a second business phone line (separate from your main phone line) as a business write-off.
If all the math above seems like a pain to sort through, you can instead take the simplified home office deduction. For the 2020 tax year, just multiply $5 by the area of your home. For a $2,000 square foot office, that’s a $1,000 deduction. Note that this deduction is limited to 300 square feet.
For more details on home office write-offs, consult IRS Publication 587: Business Use of Your Home.
Energy efficient improvements
According to the IRS form 5695, installing any of the following energy efficient improvements can lead to a tax credit:
- Solar panels/shingles
- Solar water heaters
- Small wind turbines
- Fuel cell property
- Geothermal heat pumps
- Energy Efficient improvements
This tax credit only pays for a portion of the equipment amounting to 30% of the cost of installation for most improvements. The only exception is the fuel cell property, which is limited to a $500 credit, no matter its cost, Ng says.
Write-offs on home improvements: Know the limitations
When budgeting for home improvements, you generally can’t count on tax savings to lighten the financial burden. In that sense, it’s important to prioritize improvements that not only preserve value, but that you can also comfortably afford. “When making decisions about how much to invest in your home improvements, leave possible deductions out of the conversation,” advises Ng. “Any reliance on home improvement deductions can backfire.”
DISCLAIMER: Information in this blog post is meant to be used as a helpful guide, not legal or professional tax advice. If you need help sorting through your available tax deductions related to the home and otherwise, please consult a skilled tax professional.
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