Home improvements that can lower your capital gains

Building on your basis
Uncle Sam defines basis as the amount you paid for your house. It includes settlement and closing costs and any debt. If you inherited your home, your basis is the fair market value on the day the prior owner died.

You can increase your home's basis by spending money on improvements. Just make sure the upgrades meet IRS specs. A tax-acceptable improvement must add to the value of your home, "considerably" prolong your home's useful life or it must adapt your house to new uses.

"The overriding factor is doing something that improves or enhances the value of your home," says Jamshed B. Gandi, partner with the San Francisco CPA firm of Bertorelli Gandi Won & Behti. "If the items are purely for maintenance, to maintain the home, they are not included."

Simple common sense generally will help you determine what will add to your property's basis. The addition of a bathroom or an in-ground swimming pool, for example, add to basis. Installing fancy wallpaper in the master bedroom does not.

The IRS provides a nifty chart on page 8 of its Publication 523, Selling Your Home. The list includes:

Additions such as a bedroom, bathroom, deck, garage, porch or patio
Heating and air conditioning (for example, putting in new systems)
Plumbing (for example, installing a filtration system to remedy hard water)
Interior improvements, such as built-in appliances
Insulation additions
The IRS even includes such miscellaneous items as a central vacuum, wiring upgrades or a satellite dish. So enjoy your DirecTV's 700 channels now and when you sell.

Another common and often-overlooked improvement, according to Demmett, is landscaping. Paving your driveway, erecting a fence or even putting in a retaining wall can all add value to your home, boost its basis and reduce any capital gain when selling.

Also don't forget those myriad costs associated with your house purchase. Land survey costs, attorney fees and your broker's commission all add to the value or basis of your home, notes Demmett.

Documenting your tax improvements
Experts agree that the biggest mistake that home sellers make is not documenting home improvements. Even if you have no plans to sell, hold onto every Home Depot and contractor receipt.

"People tend to lose their receipts. They need to keep all their receipts and invoices, throw them into a file," says Jeffrey J. Spengler, a senior manager in the tax department of the CPA firm of McCrory & McDowell LLC in Pittsburgh, Pa.

But don't go overboard. Homeowners often erroneously include home improvements for which they were reimbursed.

"We had a pretty wicked ice storm here a few years ago, and it seemed like everyone in my neighborhood had their roof replaced," Spengler recalls. "Since it was storm-related and paid for by insurance, this doesn't add to the value of your home."

And don't discount something just because it doesn't fall neatly into the home-improvement category. It still might be useful in offsetting possible capital gains. If you spruce up your house with a new paint job to make it more attractive to buyers, that counts as a selling expense, Spengler says. Selling expenses lower the amount you realize on the sale of home, which in turn lowers the profit you make.

Home basis in black, white and gray
Remember, too, that home improvement vs. repair is a gray rather than black-and-white tax issue. It makes good sense to run any construction projects by your tax adviser, accountant or realtor for guidance on whether the project will pass the IRS test for increasing home value.

And if the project doesn't pass?

"When an audit question comes up with the IRS about a home improvement, I'll have the auditor contact the president of the local board of realtors here," says Michael Roberts, owner of Creative Tax Solutions, a CPA firm in Laguna Hills, Calif., and chairman of the California Association of Realtors' Taxation Committee.

Local realtors can advise the IRS on what they believe are legitimate home improvements that add value. Indeed, Roberts points out that such definitions can vary by region and neighborhood. For example, in most cases, a stove replacement might be considered simple maintenance. But if you live in a posh neighborhood and you replace a four burner no-name electric stove with a six-burner upscale Viking, along with adding other pricey built-in appliances, then you've transformed your kitchen into a gourmet eatery worthy of Emeril and thus boosted the basis of your home.

"It's really funny how in one area something that might be considered an enhancement might be standard in a different area," Roberts says.

Figuring your home sale gain or loss
To determine whether you made a profit and might owe taxes on your home's sale, start with the selling price. This is the total amount received for your home, including money, all notes, mortgages or other debts assumed by the buyer as part of the sale.

Next, subtract any selling expenses, including advertising, painting or other upkeep performed to improve the appearance and marketability of the property. This will give you the amount realized.

Now subtract your adjusted basis from the amount realized. The result is your gain or loss.

You'll come out tax-free if your gain is $250,000 or less and you're a single seller; twice that amount if you and your spouse sell the house. You also must have lived in the home for two of the last five years that you owned it. (There is an exception to the time of residence requirement for military personnel.)

If your gain is more than the limits, it could be time to start digging through your records to find documentation that could help you increase your adjusted basis.

And if you sold at a loss, sorry. There is no tax break for these unlucky sellers.

Jenny C. McCune is a contributing editor based in Montana

More Home Improvement News