Certain improvements you make to your house increase what is known as the cost basis of your property. A higher cost basis can reduce the net taxable gain resulting from the sale of your home, which would result in a lower tax liability. It is important, however, to grasp what kinds of home improvement projects will increase your tax basis, since the tax law is quite specific in this regard.
The cost basis of your home is the original purchase price plus the cost of capital improvement projects. The cost basis matters, because when you sell your house, your total gain or loss from the sale equals your sale price minus your cost basis. Since the gain from the sale of your house constitutes taxable income, any increase in your cost basis may directly reduce your total tax liability.
Capital Improvement versus Repair
The tax code specifically distinguishes repairs from capital improvement projects and only accepts the cost of the latter as lawful additions to the cost basis of your home. Any work you do on your property to return it to its new condition is considered a repair. The cost of such work can therefore not be added to your cost basis. Repainting the interior of your house is a typical example of a repair and will not increase your cost basis. Capital improvements such as adding a swimming pool, remodeling your kitchen or installing permanent appliances, on the other hand, count as additions that will improve the value of your home.
Even if the project you are considering qualifies as capital improvement, you may not save on your taxes. Most homeowners are exempt from income tax on the first $250,000 of profit if they file as single, $500,000 if they file jointly as a married couple. If you expect to register a net gain of less than $250,000 from the sale of your home, there will be no additional tax savings from capital improvements.
To count as lawful additions to the cost basis of your home, the capital improvement project must still be in place at the time of sale. If you have placed a wall mounted air-conditioner 12 years ago, which has since been broken and given way to a hole in the wall, the cost of the air conditioner does not count towards your cost basis. Similarly, the appliances you put in two decades ago, which have since been replaced twice, also don't count. Only the last set of appliances that are still in place at the time of sale count towards the cost basis.
Hunkar Ozyasar is the former high-yield bond strategist for Deutsche Bank. He has been quoted in publications including "Financial Times" and the "Wall Street Journal." His book, "When Time Management Fails," is published in 12 countries while Ozyasar’s finance articles are featured on Nikkei, Japan’s premier financial news service. He holds a Master of Business Administration from Kellogg Graduate School.