Make improvements at home? Why it’s important to keep good records
This information could be useful when you go to sell.
- Selling a home for a profit may result in a tax liability.
- You can use the cost of home renovations to reduce the amount you owe the IRS.
There are many reasons why you might choose to remodel your home. On the one hand, it could improve your quality of life.
Suppose you have an unfinished basement, but your floor is full of toys for your children. If you spend money to complete this space, voila – an instant game room.
Renovations can also add value to your home, making it easier to fetch a higher price when it comes time to sell it. But if you’re planning on making improvements to your home, it’s important to keep solid records of how much you spend on them. Here’s why.
It’s about minimizing your capital gains
When you sell a stock in a brokerage account for more than you originally paid, you are subject to capital gains tax. Likewise, when you sell a home for a profit, capital gains taxes also apply.
That said, as a landlord you are entitled to a pretty decent exemption on the capital gains front. If you’re single, you can exclude up to $250,000 in gains from a home sale, and if you’re married, you can exclude $500,000. All of this assumes that you owned and lived in your home for at least two years during the five-year period before you sold this property.
So here’s how capital gains on the sale of a home might work. Let’s say you bought your house for $300,000 and you sold it several years later for $900,000 together with your spouse. Normally, you would have capital gains of $600,000. But since you can exclude $500,000, your tax liability is reduced to $100,000 of capital gains. (To be clear, you wouldn’t owe the IRS $100,000 in this situation – you would just be paying taxes on that $100,000.)
Now, here’s where home improvements come in. When calculating capital gains, you can include certain expenses in the cost of your home. These include realtor fees you incur in selling your home, as well as home improvements.
So let’s say you bought your house for $300,000 but also spent $30,000 finishing your basement. Let’s also say you paid a realtor $45,000, or 5% of the selling price of your home. In total, that’s $75,000 more than you can add to the cost of your home, bringing it to $375,000 and reducing your capital gain to $25,000.
But to count home improvements in this situation, you need records of what you spent. As you renovate over the years, be sure to keep all your receipts handy. A good bet is to scan them and store them electronically so they don’t degrade over time.
What about home repairs?
While you’re allowed to include home improvements in the cost base of your home when you go to sell it, home repairs are a different story, not least because they can’t help offset your capital gains liabilities. . So if you spend $40,000 over the years on various repairs, unfortunately you can’t add that $40,000 to the cost of your home in a sale.
But remember that every time you add something of value to your home, like a deck, fence, or pool, it could help you pay less to sell your home. So be sure to track these expenses as they happen.
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