Get A Tax Break For Home Improvement

In today’s  down market, many homeowners are reluctant to pour more money into their homes.  Before deciding whether to replace a roof or merely patch it, homeowner’s  should consider the tax implications.

Home  improvements — a new bathroom or kitchen, for example — can increase the  value of a home and reduce any taxes due on the profit earned from its sale.

Home  repairs provide no immediate tax benefits to a homeowner. They are not tax  deductible and they are not added to the home’s basis (cost), for tax purposes.  As far as taxes go, they are a nonevent. Thus, a homeowner who patches a leaky  roof gets not tax benefits.

Home  improvements are very different, though. The cost of an improvement is not  deductible, but it is added to the home’s basis for tax purposes. For example,  the cost of adding a new roof to a home is added to its tax basis. This reduces any taxable gain when the home is sold.

Of course,  a substantial amount of gain is usually tax free, anyway, under the home sale  tax exclusion: $250,000 for single homeowners and $500,000 for married owners  filing jointly. But homeowners with substantial equity can still benefit from  an increased tax basis in their homes.

For  example, if Joe and Jane purchased their home in 1990 for $250,000 and it is  now worthy $1 million, they will have a $750,000 gain. A full $500,000 of this  amount is tax-free because Joe and Jane are a married couple and qualify for  the tax exclusion.

But this  leaves $250,000 subject to taxation. If Joe and Jan had spent $250,000 adding  improvements to their home, they would have no taxable gain. This is because  the $250,000 is added to the home’s original $250,000 basis, providing an adjusted  tax basis of $500,000.

As a  result, their gain on the sale would only be $500,000, not $750,000; and this  entire gain would be tax-free because of the $500,000 exclusion.

So how do  you tell the difference between an improvement and a repair? Here’s the basic  rule provided by the Internal Revenue Service: A repair keeps a homeowner’s  property in good operating condition but it does not:

-Materially  add to the value of the property
-Substantially  prolong its useful life, or
-Make it  more useful (see: Treasury  Regulations, Subchapter A, Section 1.162-4).

In  contrast, an improvement adds to the value of a homeowner’s property, prolongs  its life, or adapts it to new uses.

The problem  with this definition is that virtually all repairs increase both the value and  useful life of the property being repaired. The key difference between a repair  and an improvement is that a repair  merely returns property to more-or-less the state it was in before it stopped  working properly. The property is not substantially more valuable,  long-lived, or useful than it was before the need for the repair arose.

In  contrast, an improvement makes property substantially more valuable and/or long-lived or useful than it was before the improvement.

You need to  compare the situation before and after you made the expenditure involved. Have  you just returned your property to the state it was in before the need for the  repair arose? Or, have you made it much better?

If the  answer to the first question is “yes,” you’ve repaired the home. If  the answer to the second question is “yes,” it’s a home improvement.

Good  examples of repairs include repainting a home, fixing gutters or floors, fixing  leaks, plastering, and replacing broken windows. Examples of improvements  include adding a deck to a home, a new bathroom, installing a new heating  system, or putting on a new roof.

Stephen Fishman is a tax expert, attorney and author who has published 18 books, including “Working for Yourself: Law & Taxes for Contractors,  Freelancers and Consultants,” “Deduct  It,” “Working as an Independent Contractor,” and  “Working with Independent Contractors.” He  welcomes your questions for this weekly column.

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