If you are a homeowner, it may have crossed your mind whether or not you get a tax break for the improvements you are making to your residence. Sometimes the answer is yes, and other times no. When it comes to fixing up your home, there are two main categories as far as the tax code is concerned - improvements and repairs.
Improvement or Repair?
Unfortunately, the IRS doesn’t provide an exact list of projects that might be considered an improvement versus a repair. However, history has provided us some good examples as to which is which. A home improvement will consist of a major project - such as a new addition, installing a central air system, installing a pool, a new roof, or adding a third-stall to your garage. Things like painting a room, carpeting the floors, or fixing the gutter system will be considered repairs.
$250,000 / $500,000 Tax Exclusion
Under current tax code, when you sell your primary home, the first $250,000 of profit (or $500,000 for married filing jointly couples) is tax free. This is only if you have lived in your home for two of the last five years before the sale. If you land in this “buffer” zone, you need not track your home improvements at all, as the profit will be tax free anyways. However, if you sell your home above and beyond this profit buffer, then any gains will be taxable. This is where tracking your home improvements will save you come tax time.
It is important to note that this tax exclusion is only applicable to one primary residence at a time. If you have a vacation home, any profit will be fully taxable - making tracking of home improvements at your vacation home crucial. If you want to sell your vacation home and also receive the tax exclusion, you will need to make it your primary residence for two years prior to the sale.
Real World Example
Now, you may be thinking, “my home is never going to appreciate more than $250,000, so I won’t even bother keeping track of my improvements.” All you need to do is look at a neighborhood like East Nashville, where a currently listed home sold in 2015 for $87,500 and is now listed at $500,000. We can make an assumption that this owner has made major improvements to the home to increase the value. If this is a single individual, they would have a taxable gain of $162,500 ($500,000 sale price - $87,500 purchase price - $250,000 exclusion = $162,500). By tracking the home improvements they’ve made the past few years, a portion or all of that taxable gain could potentially be deducted.
How To Track
In order to be able to deduct home improvements on your tax return, you need to keep good records. Be sure to have a good filing system where you can place all of your receipts and invoices for the expenses you incur for your home improvements. You will want to keep a separate folder for each project you complete while owning your home.
To ensure that your physical records aren’t destroyed over the years (the dog ate my homework), you should also save the records online or on your computer. Cloud storage providers like Google Drive or Dropbox make it really easy to scan in your documents and make them accessible anywhere with an internet connection.
Lastly, with each project, it doesn’t hurt to write a short summary of the work completed. This can be done in one page or less, but you should explain what improvements were made, when, who completed them, and at what total cost. This will help you recall the project in detail when you try to claim the deduction years down the road.