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As much as we might all wish for there to be an all-you-can-eat buffet of tax deductible home improvements, this just isn’t the case. In fact, home improvement tax benefits are actually hard to come by.
But this doesn’t mean they don’t exist. Read on to find out how some taxpayers are able to find benefits in home ownership come tax time.
First off, what qualifies as an improvement? Well, the IRS has strict rules for this that have seen much action in court. Generally, an improvement is something that increases the value of a property. Examples include a physical expansion, a renovation, restoration or an adaptation for a different use. These differ from maintenance and repairs, which merely keep the property in efficient operating condition.
Interestingly, there is somewhat of a sliding scale between repairs and improvements. For example, let’s say you called in a repair company to fix a leaky roof and an inspection revealed that the entire roof must be replaced. Your little roof repair just became an improvement. Replacing a broken window pane is a repair, replacing an entire window, casement and all is an improvement.
To the extent there is a tax deduction, treatment of maintenance and repairs is far more beneficial because you can deduct the entire expense in the tax year it was incurred. Deductible expenses for improvements, on the other hand, must be depreciated over a lengthy period, typically 27.5 years.
Reduction, Not Deduction
Because real property tends to increase in value over time, there is one tax benefit most homeowners can realize with the passage of enough time. Home improvements can reduce the amount of taxes you owe on any profit you might make on the sale of your home. Home improvement expenses increase your ‘basis’ at the time of sale. This can have a big impact on reducing your profit on paper and results in a smaller capital gains tax obligation.
For example, if you bought your home for $250,000 in cash and sold it for $400,000 a year later, your taxable capital gain would be $150,000. But, if you could show that you made $50,000 of home improvements, your basis would be $300,000 and your taxable capital gain $100,000.
Be sure to keep a file of all your home improvement expenses over the years, you’ll want to have these handy when the time comes to sell your home. Home repairs, alas, do not factor into your basis. Learn more from the IRS about calculating the cost basis of your home.
Home Office Tax Deductions
If you use part of your home solely and regularly as an office for a legitimate business you can deduct many of your home improvement costs. If the improvements are made only to the office space you can deduct 100% of the costs. If the improvements are made to the entirety of the home (new siding, new windows, new air conditioner, etc.) you can deduct a prorated amount of the cost. For example, if your home office makes up 10% of your home’s total square footage, you can deduct 10% of the home improvement costs.
It is important to note, however, that you can’t just deduct the entire cost of these improvements in a single year. Instead, they must be depreciated over several years. Read this IRS article for instructions on deducting expenses for business use of your home.
Rental Property Tax Deductions
Much like a home office, if you rent out a portion of your home, improvements you make can create a tax benefit. And, as with home office improvements, rental property improvements can be entirely or partially attributed to the rental space but must be depreciated over a period of years.
As discussed above, the IRS distinguishes between maintenance & repairs vs. improvements. Painting or refinishing a floor can be deducted in a single year while a new furnace will need to be depreciated. Learn more about what improvement costs qualify as deductions and how to calculate them in IRS Publication 527.
Solar Energy Tax Credit
Tax credits are more beneficial to overall tax savings than are tax deductions. This is because you can deduct the credit directly from the amount of taxes that you owe, not from your income like a tax deduction. This makes the solar energy tax credit a powerful incentive to install solar energy panels or a solar water heater.
The Solar Energy tax credit, for 30% of the equipment and installation costs of these items, is a great way to save on energy costs for your home, feel good about using a renewable energy source, and save money on your taxes. Talk about a win-win!
Just know that to qualify for the credit the equipment must be used to generate power or heat water in your primary or secondary home — not for something like a swimming pool. Also, Solar Energy tax credit will remain in place through 2019 but is scheduled to begin winding down thereafter.
This credit used to apply to energy-efficient windows, doors, siding, insulation, and heating & cooling systems. However, these tax benefits came to an end in 2016.
Learn more about the last remaining Energy Star tax credit here.
Your Home Improvement Tax Deductions and Credits
With the exception of the Solar Energy tax credit, the tax benefits of home improvements are indirect. Reducing your capital gain by increasing your home’s basis only benefits you at the time of sale. Meanwhile, any yearly depreciation deductions exist only when there is a business use – either a home office or rental space.
As a result, while you should certainly take advantage of any opportunities these deductions create, they shouldn’t be primary drivers for your decision to make the home improvements. Instead, perhaps the focus of your decision should be on your long-term enjoyment of your home. If there happens to be a tax benefit down the road, so much the better.