You might have to pay capital gains taxes on the difference between what you paid for the house and how much it sold for. But some changes you make to your home while you own it can lower the taxable gain and your tax bill. To get the most tax breaks, you need to know what counts as a deductible capital improvement.
What Are Capital Improvements?
The IRS distinguishes capital improvements from regular repairs and maintenance. Repairs simply restore a home to its original condition, while capital improvements add value by enhancing or upgrading the property.
To qualify for capital gains tax deduction an improvement must
- Add value, extend the useful life, or adapt the home to new uses
- Have a useful life of more than one year
- Still exist at the time of sale
Simply maintaining your home in working order doesn’t count Capital improvements involve more extensive upgrades and additions,
Examples of Deductible Capital Improvements
Here are some common projects that can be deducted from capital gains when you sell your home:
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Adding living space Finishing a basement, converting an attic, building an addition like a sunroom
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Major remodels: Kitchen upgrades, opening up floor plans, installing built-in appliances.
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Outdoor additions: Decks, patios, porches, detached garages, swimming pools.
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Systems upgrades: New roof, windows, siding, insulation, HVAC, plumbing, electrical systems.
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Landscaping: Trees, sod, irrigation, fences, stone walls and patios. Driveways, walkways, lighting systems.
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Security: Fire protection systems, security systems, emergency generators.
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Accessibility: Wheelchair ramps, stair lifts, accessible showers and tubs.
As a rule of thumb, larger projects that improve functionality, efficiency, aesthetics, or comfort qualify. Upgrading outdated or damaged systems to modern standards also counts. Small repairs or routine maintenance like painting, appliance repairs, carpet cleaning, etc. do not qualify.
Costs That Can Be Deducted
You can deduct the fair market value of any qualifying capital improvements from your home’s taxable gain. This includes:
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Contractor labor and materials
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Permit fees, inspection costs, architectural plans
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Related expenses like debris removal or utility connections
To keep track of the costs, keep detailed records like contracts and invoices. Appraisals of a home before and after major renovations can also help figure out its value.
How the Deduction Is Calculated
If your home goes up in value after you sell it, you will have to pay capital gains taxes on the difference. This is how much you paid for the house in the first place, plus costs like closing fees and repairs.
For example:
- You bought your home for $200,000
- You made $40,000 in capital improvements over the years
- Your home sells for $350,000
The gain would be $150,000 if the deductions were taken away ($350,000 sale price – $200,000 original cost). But you can deduct the $40,000 spent on capital improvements. The taxable gain drops from $350,000 to $110,000 ($200,000 – $40,000).
Depending on your tax bracket, that $40,000 deduction could reduce your capital gains taxes by $4,000 to $8,000.
Limitations and Considerations
A capital improvement deduction won’t benefit all homeowners:
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If your gains are under the capital gains exclusion limits ($250k single, $500k married filing jointly), you won’t owe taxes anyway.
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Improvements must still exist at the time of sale to qualify. Replacing items like carpeting before selling makes them non-deductible.
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You can’t deduct expenses that were subsidized by tax credits or rebates.
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Keep detailed records and receipts to validate deductions in case of an audit.
For primary residences, capital gains taxes don’t apply to the first $250k profit for single filers or $500k for married couples. So focus on improvements that boost value well beyond your potential excluded gains.
Consult a tax professional to understand how capital improvements might impact your specific tax situation. With proper planning and documentation, this deduction can help many homeowners reduce taxes owed on home sale profits.
Bottom Line
When selling your home at a substantial profit, capital improvements you’ve made over the years could potentially lower your tax bill. Additions, renovations, upgrades that improve functionality or efficiency generally qualify. But repairs and maintenance that just retain existing value won’t count. Keep detailed records and factor this deduction into your overall tax planning strategy.
Ownership and Use Test
To qualify for the home sale exemption, you must pass both the ownership and use tests:
- Ownership Test: You must have owned the home for at least two out of the five years preceding the date of sale.
- Use Test: You must have used the home as your principal residence for at least two out of the five years preceding the date of sale.
These two years do not have to be continuous, and they do not have to overlap.
Special Circumstances and Partial Exclusions
Certain circumstances may allow for a partial exclusion if you do not meet the full two-year requirements. These include:
Change of Place of Employment: If you need to sell your home due to a job change that qualifies as a long-distance move.
Health Reasons: If you need to sell your home for health-related reasons.
Unforeseen Circumstances: These might include events like: natural disasters, death, divorce, or multiple births from the same pregnancy.
In these cases, you may be eligible for a prorated exclusion based on the time you owned and used the property as your principal residence.
What Home Improvements Can Be Deducted From Capital Gains? – CountyOffice.org
FAQ
What improvements can be offset against capital gains tax?
Laying out the garden in a new way, building new patios, adding a summer house or garden office, putting in lighting or drainage systems, or… February 22, 2025
What home improvements are against capital gains?
The Bottom Line. A capital improvement is a permanent alteration to addition to a property that increases its value or useability. Residential capital improvements are granted special tax treatment: the money spent to improve a home can be deducted from the capital gains when the home is sold.
Can renovation cost be deducted from capital gains?
Capital Improvement Deduction Basics Funds spent to improve a home can be deducted from the capital gains when a home is sold, potentially reducing capital gains taxes. The deductible expenses have to be for improvements that last more than a year.
What can you deduct from home sale capital gains?
You can subtract some closing costs, sales costs, and the property’s tax basis from your taxable capital gains, along with the price you paid for it in the first place. Jan 8, 2025.