Most homeowners know that their home entitles them to some federal tax breaks, chief among them, deductions based on mortgage interest and property taxes that they pay annually. However, first-time home buyers and sellers, and even seasoned homeowners, may not know about other tax breaks for home improvements.
Always consult a qualified tax adviser when trying to determine your potential tax liability; however, here’s a rundown of ways you may be able to save on your taxes by making home improvements both large and small.
1. Selling your home: capital improvements that change your cost basis
As soon as you purchase your home, you should start a file and save receipts, contracts, or other relevant documentation that show costs for all of your major remodeling and home upgrade projects you make over the years. When you sell your home, you may be able to add the costs of major upgrades to your original purchase price to increase your adjusted cost basis. The more upgrades, the more you may be able to reduce your capital gains or even show a loss on the sale of your home for tax purposes.
The IRS considers the following examples as capital improvements that may be used to increase your cost basis:
- Additions. These include new or expanded rooms that were not part of the home you purchased such as extra bedrooms, bathrooms, a deck, garage, porch, and patio.
- Grounds and landscaping. Things like a new lawn or xeriscaping, a new driveway, walkway, fence, in-ground pool, or retaining wall fall into this category.
- Home systems. Systems include heating and central A/C, a new furnace, duct work, security system, upgraded electrical wiring, water and air filtration, and central vacuum. An outdoor irrigation system and new plumbing such as water heaters and modern pipes are also part of your home’s systems.
- Exterior improvements. Installing new siding, windows and doors, a roof, and even a satellite dish can qualify to boost your adjusted basis.
- Interior upgrades. Flooring (including carpeting), built-in appliances, and kitchen modernization count toward increasing your basis.
- Insulation. Adding insulation to your pipes, duct work, walls, attic, and floors qualify as upgrades.
- Repairs. Most repairs CANNOT be included in your basis adjustment unless they are a necessary part of completing a larger remodeling project. If, for example, you’re having all your windows restored or replacement windows installed, repairing rotted wood around the window frames could qualify as part of that cost.
You can check IRS publication 523, Selling Your Home; 530, Tax Information for Homeowners; and 551, Basis of Assets, downloadable for free at irs.gov, for more detailed information.
2. Tax credits for energy-saving home improvements
While the Energy Incentives for Individuals in the American Recovery and Reinvestment Act expired at the end of tax year 2013 for many energy-efficient home upgrades such as replacement windows, the Residential Energy Efficient Property Credit is available through December 31, 2016. Homeowners can benefit from upgrading to certain alternative energy systems that pay off in tax credits for installing and using the following types of equipment:
- Small solar energy systems that generate electricity or heat water
- Geothermal heat pumps that can provide heating, cooling, and/or hot water
- Residential wind turbines that convert wind to electricity
- Fuel cells and microturbines that produce energy from natural gas or propane
File IRS Form 5695 to recoup 30 percent of the purchase and installation costs with no maximum, with the exception of fuel cells and microturbines that have a $500 cap. Keep in mind that tax credits reduce your home’s adjusted basis by the amount of the credit you receive.
3. Medical home improvements: capital expenses
If you, your spouse, or a dependent requires physical accommodations that necessitate remodeling because of a medical disability, the cost may qualify as a medical expense. If the home improvement increases the value of your home, the expense is reduced accordingly. For medical modifications that do not increase your home’s value, you can include the entire cost as a medical expense. Architectural and aesthetic improvements to your home do not qualify. IRS Publication 502 contains a worksheet to determine capital expenses considered true medical expenses such as the following:
- Grab bars and railings
- Widening doorways
- Lowering kitchen cabinets
- Modifying door handles
4. Interest deductions for certain home improvement loans
If you take out a loan to make capital improvements to your home (improvements that increase its value, improve its longevity or modify it for new uses), you may be able to deduct the interest on your taxes. Loans for repairs may not qualify for some home improvement loans. However, home equity lines of credit (HELOCs) can be used for a variety of purposes, and some 203k mortgages allow you to make many types of remodels and repairs to make a home livable. Interest for these types of mortgage loans on your main or second home is typically tax deductible.
5. State and local tax credits for energy-efficient improvements
In addition to saving tax dollars when you file your return with the IRS each year; energy-wise home upgrades may also entitle you to some additional tax incentives from your state and local governments. The Database of State Incentives for Renewables & Efficiency® (DSIRE) allows you to filter and search for a wide array of tax credits, rebates and other incentives available locally.