REAL ESTATE TOPICS...What You Need to Know About Home Improvements and Taxes

When it comes to taxes, repairs and improvements aren’t always treated the same.

When we bought our first house, it was perfect. Well, except for the 40-year-old heater. And the green kitchen with beige appliances circa 1970s. And the creepy basement. But otherwise perfect.

Over the years, we made a number of improvements. We also made a number of repairs. We replaced the roof, added a powder room, and replaced the front porch. We painted walls and swapped out windows and doors.

When we sold our house a few years ago, I still had a list of things that I had wanted to make happen that we never got around to doing. We never did refinish the basement or knock out the kitchen wall. I never got a new master bath. Like many homeowners, my husband and I weighed what we wanted to make happen against what needed to happen: time, money, and resale value were all factors.

When you pay for a repair or an improvement to your house, the immediate hit to your wallet is the same. However, how that repair or improvement is characterized determines whether you might get a break down the road.

Here are a few rules for sorting it all out.

What constitutes a repair?

For tax purposes, a repair returns your home to its previous condition but doesn’t necessarily make it better than before. To figure how the repair will be treated on your return, you’ll want to consider the nature and timing of the repair.

Repairs that you make simply to make your home look or feel better — like patching and painting the walls — offer no tax advantage: they’re tax neutral.

Repairs that you make following a fire, hurricane, tornado, or other disaster may be deductible under the casualty/loss rules. The rules can be complicated, but generally you can deduct the cost of a repair to return your property to the state it was in before the disaster.

BECOME A CALIFORNIA REAL ESTATE AGENT...CLICK LOGO TO VIEW OUR LIVE LECTURE SCHOOL

What’s the difference between a repair and an improvement?

While repairs restore your home to its original condition, home improvements make it better and can boost the sale value. As a rule, you don’t get to take a tax deduction for increasing the value of your home — with a few exceptions.

If the improvement is to accommodate a disability, you can claim some or all of the cost as a medical expense. This would include, for example, the cost of a wheelchair ramp. If the cost of the home improvement does not increase the value of your home, you may claim the entire amount as a medical expense; if the improvement increases the value of your home, the difference would be a medical expense. Remember that the rules for medical expenses still apply, including the 10% floor.

What about energy-efficient upgrades?

If you improve your home using alternative energy, you may qualify for an energy tax credit — at least through 2016. The Residential Energy Efficient Property Credit is equal to 30% of the cost of qualified equipment. Qualified equipment includes solar water heaters, solar electric equipment, and wind turbines. There is no cap on the credit for most types of property and the improvements don’t have to be made to your main home.

Can updates to a home office be deducted?

If you make a repair to or improve part of your home that you use for business, including a home office or a rental, you can claim a deduction. You’ll want to make sure that the repair meets the criteria for business expenses to take the deduction. You may also have to deduct the cost over time, so check the rules carefully.

What if none of these circumstances apply?

All is not lost. If your home improvements are considered capital improvements, you may still get a break by increasing your basis for purposes of calculating a gain or a loss when it comes time to sell.

Here’s my rule of thumb for figuring capital improvements: if you can carry it out of your house (like that microwave), it’s not a capital improvement. If you can’t take it with you when you go (like that master bath), it’s probably a capital improvement.

Here’s how it works by the dollars. Let’s say I bought my house for $100,000. And let’s assume that I really did get around to adding that master bath at a cost of $10,000.

My new basis? $110,000. That’s $100,000 (purchase price) + $10,000 (adjustment) = $110,000. At sale, I would figure any capital gain (difference between selling price and basis) with an adjusted basis of $110,000.

The reality is that you can’t always plan your repairs or home improvements around your tax return. Leaky roofs and disabilities don’t always show up when it’s convenient. But knowing the rules ahead of time can help you ease the hit to your wallet — and help you time the improvements that you can control.