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

Home Improvement & Tax Deductions: What's Deductible & What's Not
••• RicardoImagen/E+/GettyImages

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. While the Internal Revenue Service only allows you to deduct costs for home improvements if you meet some limited criteria, your improvements could still help you financially when you sell your home. There is also some tax help available for certain improvements that make your home more 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 getting immediate tax deductions for making repairs or improvements to your personal residence that you don't rent out or work from on a regular basis, the IRS considers these personal expenses in most cases. Therefore, the costs normally don't count as a deduction on your return on their own. For example, if you install new plumbing, add a paved driveway, renovate your kitchen or install a new roof, you don't get to report those as expenses even if you itemize on your return.

However, 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. Further, if you rent that home (or part of it) out to somebody and serve as the landlord, you can account for such costs through expense deductions or depreciation.

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

Tax Benefit for Home Sale

In most cases, improvements to your personal residence tend to increase its value. This becomes important when you decide to sell your house since having invested in additions can reduce your capital gains tax if you sell for a significant amount higher than what you originally paid for the house. How this works is that the IRS determines your home's cost basis as what you paid originally plus improvements, and this gets subtracted from the sale price to determine your capital gains. Capital gains tax rates range from ​0 to 20 percent​ and depend on your income.

The IRS rules let you have either ​$250,000​ (if single) or ​$500,000​ (if married) in gains on your home sale and exclude those from capital gains taxes as long you've owned and occupied the home for a minimum of two years within the last five, and you haven't already used this exception within the last few years. So, if a ​$250,000​ home had ​$50,000​ in improvements, its new basis would be ​$300,000​. Thanks to your improvements, you could make a substantial profit before having to pay those capital gains taxes.

Accounting for this information and determining capital gains taxes happens on Schedule D. You enter the sale price for your sold home and the cost basis (including your improvements) to determine whether you saw a gain or loss.

Home Improvements for Medical Needs

While you can't deduct most home repairs and improvements for your personal residence, one exception is if you itemize on your tax return and have had to make certain home improvements due to a medical need. For example, consider that you need to add a ramp to your house for a family member who uses a wheelchair, that you needed to alter the stairs for safety or that you needed to 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

To qualify for this home improvement deduction, you first need to itemize your deductions and then meet an IRS test to determine if the cost of that medical-related home improvement exceeds ​7.5 percent​ of that tax year's adjusted gross income. If so, that doesn't mean you can just deduct the whole amount. Instead, you can deduct the amount beyond the ​7.5 percent​ figure. This can mean you don't actually get much of a tax break in the end.

Consider that you spent ​$2,000​ to install ramps outside your home and had an adjusted gross income of ​$40,000​ for the year. In that case, your expense didn't meet the ​7.5 percent​ threshold, which would be ​$3,000​. On the other hand, had the expense been ​$10,000​ with a ​$40,000​ adjusted gross income, you could deduct ​$7,000​ since that's the amount past the adjusted gross income threshold.

If your situation qualifies, you can report these expenses on the Schedule A form's section for medical and dental expenses.

Home Improvements for Home Office

The IRS is more flexible in potential 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 where your home office resides.

For example, if you added a new air conditioning system to your house where just one room makes up your home office, you would get a partial benefit for the part of office space. However, if you repaired the broken door to your home office room, that could get a full deduction.

Depending on the type of expense, you have to determine whether it was a repair to your home office space or a general home improvement, as this determines if you 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. However, the air conditioner would be an improvement where you'd prorate to account for your home office space and depreciate that cost over its useful life, which can be for many years.

Taking the Home Office Deduction

Before you try to deduct for home office repairs and improvements, you need to meet the strict home office criteria, have documentation for the expense and prove that it didn't change your home's current business use. Namely, your home office space needs to be used exclusively for work activities and be a 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 personal. The IRS doesn't exclude you from doing any work outside your home office space though.

To take full advantage of deductions for home improvements, you need to go with the actual expense method for the home office deduction. This means you 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 get listed on ​line 20​ of Form 8829. You complete Part III to determine the depreciation expense to deduct for your home and then put that number on ​line 30​.

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

Home Improvements for Rental Properties

Like those who have a home office in their homes, you can get tax benefits if you make regular repairs to a house that serves as a rental property, 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. At the same time, you need to 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 that tax year. These include things like repairing a leaky faucet, replacing a few roof shingles, getting the furnace fixed and repairing a hole made in the wall.

Like with home office improvements, you need to depreciate any expenses that lead to improvements – such as new rooms, remodeling work, full roof replacements and new lighting systems – to the rental house. If these improvements impacted the whole house and you only rent out part of it, then you need to calculate the percentage that qualifies.

Deducting Rental Improvements and Repairs

While you can likely easily determine repair costs by looking through old receipts and repair requests, you need to 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 usually depreciate additions like new furnaces over ​27.5 years​, new fences over ​15 years​ and carpets over ​5 years​.

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

Understanding Home Improvement Tax Credits

Along with home improvement and repair costs that may be deductible, you could qualify for tax credits if you make certain improvements that boost your home's energy efficiency. These work differently from deductions in that you subtract the amount offered by the credit from your actual taxes due. The home improvement deductions, on the other hand, just work to reduce the income subject to taxes.

If you installed solar energy systems, a geothermal heat pump, a wind turbine or similar addition to your home, the residential renewable energy tax credit can give you a tax credit in the form of ​26 percent​ of the system cost for the 2020 tax year. This amount will drop to ​22 percent​ for systems installed in 2021. You need to make sure your addition meets the energy savings criteria, and some systems need to have Solar Rating Certification Corporation approval,

Nontraditional Home Improvement Tax Deduction

Besides the deductions and credits discussed so far, you could potentially get a tax deduction if you choose to itemize and used a home equity loan or mortgage to fund your home improvements. While the Tax Cuts and Jobs Act has changed the home mortgage interest deduction with limits set by filing status, it still allows you to deduct mortgage interest associated with loans used for home improvements. This includes qualified costs rolled into such loans.

Under the current law, you can deduct interest paid on as much as ​$750,000​ in home loans (married taxpayers filing separately get a ​$375,000​ limit) on your Schedule A. When taking this deduction, though, you need to make sure the tax savings justify forgoing the standard deduction, which can be as much as ​$24,800​ if you're a qualifying widow or married taxpayer filing jointly.

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