Home Improvement & Tax Deductions: What's Deductible & What's Not

Home Improvement & Tax Deductions: What's Deductible & What's Not
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Whether you've added something as simple as a new window or completed a detailed renovation to add a room, you'd like to get some of the money you spent back through tax deductions. The Internal Revenue Service only allows you to deduct the costs for home improvements if you meet some limited criteria, but your improvements could still help you financially when you sell your home.

There's also some tax help available for certain improvements that make your home more energy efficient. Learn when you can and can't deduct your home improvement costs as well as what credits are available.

Home Improvement Deduction Overview

When it comes to claiming immediate tax deductions for making repairs or improvements to your personal residence, the IRS considers these to be personal expenses in most cases unless you don't rent the property or you work from on a regular basis. The costs normally don't count as a deduction on your tax return on their own. You don't get to claim the expenses even if you itemize on your return if you install new plumbing, add a paved driveway, renovate your kitchen or install a new roof,

But the IRS does allow you to deduct repair and improvement costs when your personal residence contains a qualified home office or when you've incurred an improvement expense due to a legitimate medical need. And you can account for such costs through expense deductions or depreciation if you rent that home (or part of it) out to somebody and serve as the landlord.

You won't be able to deduct the cost if you don't qualify under any of these criteria, but you could see tax savings when and if you sell the property later, depending on your home's original cost and the sale price.

Tax Benefit of a Home Sale

Improvements to your personal residence tend to increase its value in most cases. This becomes important when you decide to sell your house because investing in additions can reduce your capital gains tax if you sell for a significant amount higher than what you originally paid for the house.

The IRS determines your home's cost basis as what you originally paid for it plus improvements. This number is subtracted from the sale price to determine your capital gains. Capital gains tax rates range from ​0 to 20 percent​ if you own the home for longer than a year. The rate depends on your income.

But the IRS has special rules for a home you use as a residence. You can exclude either ​$250,000​ (if you're single) or ​$500,000​ (if you're married) in gains on your home sale from capital gains tax as long as you've owned and occupied the home for a minimum of two years within the last five. You don't have to own and occupy it for the same two-year period. Thanks to your improvements, you could make a substantial profit before having to pay those capital gains taxes.

You must account for this information and determine any capital gains taxes on Schedule D. You'll enter the sale price for your sold home and the cost basis (including your improvements) to determine whether you saw a gain or loss. You must file Schedule D with your 1040 tax return.

Home Improvements for Medical Needs

You can't deduct most home repairs and improvements for your personal residence, but an exception exists if you itemize your deductions and you had to make certain home improvements due to a medical need. Maybe you had to add a ramp to your house for a family member who uses a wheelchair, or you had to alter the stairs for safety or make your doors wider. Other medical-related improvements that could qualify include putting handrails in your shower, installing lifts or making the ground more level outside your home.

Deducting for Medical-Related Improvements

You must itemize your deductions to claim this home improvement deduction, then you must meet an IRS test to determine if the cost of that medical-related home improvement exceeds ​7.5 percent​ of your adjusted gross income for the year. You can only deduct the amount beyond the ​7.5 percent threshold​. This can mean that you don't really end up with much of a tax break.

Consider that you spent ​$2,000​ to install ramps outside your home. You have an adjusted gross income of ​$40,000​ for the year. Your expense doesn't meet the ​7.5 percent​ threshold in this case, which would be ​$3,000​ ($40,000 times 7.5 percent). You would have been able to deduct ​$7,000​ if the cost had been $10,000 and your adjusted gross income was $40,000.

You can report and claim these expenses on the Schedule A form's section for medical and dental expenses if you qualify.

Home Improvements for Home Office

The IRS is more flexible with deductions for home improvement costs associated with maintaining a home office. Depending on whether the improvement benefited just your home office area or the home as a whole, you could get a tax benefit for the full amount or prorate the amount based on the fraction of your home that your home office takes up.

You would get a partial benefit for the part of office space if you added a new air conditioning system to your house where just one room makes up your home office. But you could claim the full cost if you repaired the broken door to your home office room.

You must determine whether it was a repair to your home office space or a general home improvement, depending on the type of expense. This determines if you can deduct the cost or depreciate it. The example with fixing the home office's door would be a repair that you could deduct in full for that tax year. But the air conditioner would be an improvement you'd have to prorate to account for your home office space. You'd have to depreciate that cost over its useful life, which could be many years.

Taking the Home Office Deduction

You must meet some strict home office criteria in order to deduct for home office repairs and improvements. You'll need documentation for the expense and you'll have to prove that it didn't change your home's current business use. Your home office space must be used exclusively for work activities. It's the place where you primarily do business. It doesn't have to be a separate room, but the same area can't be used for anything else. You can't claim your kitchen table as a home office because you presumably also eat there. But the IRS doesn't exclude you from doing any work outside your home office space.

You must use the actual expense method for the home office deduction to take full advantage of this type of home improvement. You must itemize each home office expense either in full or as a percentage based on your home office space and home size. Repairs and maintenance expenses for qualified home offices are listed on ​line 20​ of the 2021 Form 8829, which you would file with your tax return in 2022. Complete Part III to determine the depreciation expense you can deduct for your home and then enter that number on ​line 30​.

If you come across an expense that did change your home's use, you won't deduct it here on Schedule A. You would add that improvement amount to your house's basis as you would with general home improvements.

Home Improvements for Rental Properties

You can claim tax benefits if you make regular repairs to a house that serves as a rental property as well, or if you pay for more substantial improvements that create long-term value. The type of expense determines whether you can fully deduct it or whether you need to depreciate it over a specific period of time that the IRS sets. You must prorate costs if only part of that home is rented out.

You can fully deduct your repair costs to the part rented out as an expense in that tax year. These include things like repairing a leaky faucet, replacing a few roof shingles, getting the furnace fixed and repairing a hole in the wall.

As with home office improvements, you must depreciate any expenses that lead to improvements to the rental house. This might include new rooms, remodeling work, full roof replacements and new lighting systems. You must calculate the percentage that qualifies if these improvements impacted the whole house and you only rent out part of it.

Deducting Rental Improvements and Repairs

You can easily determine repair costs by looking through old receipts and repair requests, but you must do a little more work to find the depreciation period to use for the improvement. IRS Publication 527 has a table that can help you identify the depreciation length for the category of home improvement. For example, you'd depreciate additions like new furnaces over a period of ​27.5 years​, new fences over ​15 years​ and carpets over ​five years​.

Fill out Schedule E when you've determined the amounts for home improvements and repairs that apply to your rental home. You can list repairs for up to three rental properties on ​line 14​, and you can enter depreciation for up to three properties on ​line 18​.

Understanding Home Improvement Tax Credits

You might also be able to qualify for certain tax credits if you make improvements that boost your home's energy efficiency. These work differently from deductions in that you subtract the amount of the credit directly from your actual taxes due. The home improvement deductions can only reduce your taxable income. They're subtracted from your adjusted gross income on your Form 1040 tax return.

The residential renewable energy tax credit can give you a credit of ​22 to 30 percent​ of the system cost for the 2021 tax year if you installed solar energy systems, a geothermal heat pump, a wind turbine or similar addition to your home. The percentage depends on the year in which you paid for the installation. Make sure your addition meets the energy savings criteria. Some systems require Solar Rating Certification Corporation approval,

Nontraditional Home Improvement Tax Deduction

You might also potentially claim a tax deduction if you choose to itemize and you used a home equity loan or mortgage to fund your home improvements. The Tax Cuts and Jobs Act has changed the home mortgage interest deduction with limits set by filing status, but it still allows you to deduct mortgage interest associated with loans used for home improvements. This includes qualified costs rolled into such loans.

You can deduct interest paid on as much as ​$750,000​ in home loans (married taxpayers filing separately get a ​$375,000​ limit) on Schedule A. But make sure the tax savings justify forgoing the standard deduction, which can be as much as ​$25,100​ for ​tax year 2021​ if you're a married taxpayer filing a joint return with your spouse. You can't claim the standard deduction and itemize other deductions, too.

Keep these deductions and credits in mind so you know how to take advantage of home improvement tax perks this tax year. And keep in mind how your home's value will increase as you improve it, even if you don't qualify for a tax break now.