Documenting Home Improvements
Why Keep Track of Home Improvements
Homeowners receive a generous exclusion on the gain of their principal residence up to $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly. Most people probably consider the gain or profit in a home to be the difference between the purchase price and the sales price.
IRS allows a taxpayer to lower the sales price by the selling expenses before calculating gain. Normal expenses like real estate commission, title policy, attorney fees, and other sales expenses may be included if they are normal and customary.
Another significant adjustment is that capital improvements made during the holding period can be added to the cost basis. Normal maintenance like repairs are not considered improvements. IRS says that if the expenditure materially adds value (features) to the property, or appreciably prolongs the useful life of the property, or adapts a portion of the property to a new use, it can be considered a capital improvement.
Examples could include replacing a heating or air conditioning system, storm windows, new permanent landscaping like trees or shrubs or completing an unfinished basement. They don’t necessarily have to be high-ticket items but can include things like adding dead bolts, ceiling fans, video doorbell and other items. For more information, see IRS Publication 523.
The total amount of the money that is spent on capital improvements increase the cost basis of the home which in turn will reduce the amount of gain when sold. With the average person staying in a home for 10 … 12 years, the total improvements could be significant.
As an example, let’s say a single taxpayer sold their home for $350,000 more than they paid for it. If their selling expenses were $25,000 and they had made $75,000 of capital improvements during the holding period, the gain would be $250,000 and within the limits for a single taxpayer to exclude all of it instead of having a $100,000 gain.
It is necessary to be able to prove the amount spent and for that reason, a routine should be established to keep the receipts and cancelled checks for all expenditures on their principal residence. Even if the owner is not sure whether they qualify as an improvement, by having the receipt available at the time of sale, a tax professional can help a homeowner with the determination.
In addition to receipts and cancelled checks, a contemporaneous register listing the date, description and amount spent will provide accurate information for calculations and serve as evidence should it be needed in the future.
There is more information in the Homeowners Tax Guide that is available for download.
If you would like any professional residential Real Estate advice, contact us at Paramount Real Estate Services. 1008 12th St. SE Salem, OR 97302 503-851-1645
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Is Mortgage Interest Deductible?
Some Mortgage Interest May Not be Deductible
Banks are concerned about making loans that will be repaid not about making loans that are tax deductible for homeowners. It is good business for the bank but how is the homeowner supposed to know?
Most homeowners and potential homeowners are aware there are tax benefits associated with ownership. For instance, mortgage interest and property taxes have been deductible expenses from federal income tax since it was enacted in 1913.
The current law provides that homeowners can deduct the interest on Acquisition Debt which is the amount of debt incurred to buy, build or improve a first or second home up to $750,000. The amount of acquisition debt decreases as payments are made and it cannot be increased unless the additional funds borrowed are used for capital improvements.
It is not uncommon for a homeowner to refinance their home for any number of reasons. It could be to get a lower interest rate that would lower the payments or remove mortgage insurance. However, when additional funds are borrowed for reasons beyond “buy, build or improve”, the excess is considered personal debt and the interest is not deductible according to IRS.
Maybe this is not important if the owner is taking the standard deduction because it is higher than the total of the property taxes, qualified mortgage interest and charitable deductions made by the taxpayer. Currently, it is estimated that 90% of homeowners are electing to use the increased standard deduction implemented with the 2017 Tax Cuts and Jobs Act.
A confusing issue that occurs at the end of the year is when the lender reports to the borrower the amount of interest that was paid. While that amount is most probably accurate, the bank doesn’t know if it is qualified mortgage interest for the borrower.
It is the responsibility of the taxpayer to keep track of outstanding acquisition debt and whether part of the balance is considered personal debt.
Another area where it could become important is if the property was lost due to foreclosure, deed in lieu of foreclosure or a short sale. The provisions of the Mortgage Forgiveness Act have been extended through 12/31/20 which exempts the forgiven debt from being considered income and therefore taxable. However, it only applies to acquisition debt. Any part of a mortgage refinance that is considered personal debt could be taxable in that situation.
As an example, let’s say that homeowners originally borrowed $300,000 to purchase a home that they owned for 15 years. During that time, the home appreciated significantly, and they refinanced it twice. Once, they made some improvements and took out cash to pay off personal loans and the second time, it was only a cash out.
| Original acquisition debt |
$300,000 |
| Remaining acquisition debt including improvements |
225,000 |
| Unpaid balance on current mortgage |
$550,000 |
| Personal debt |
325,000 |
In the example above, the personal debt of $325,000 would be considered income on foreclosure and recognizable as income on that year’s income tax return.
If you have never refinanced your home or have refinanced it but never taken any money out of it except to make capital improvements, your unpaid balance in most likely acquisition debt. However, it you have refinanced your home and pulled money out of it for purposes other than capital improvements, those funds may be considered personal debt.
This article is for information purposes. If you are unclear about the current acquisition debt on your home or need advice for your individual situation, contact your tax professional. Additional information can be found in IRS Publication 936, Home Mortgage Interest Deduction.
If you would like any professional residential Real Estate advice, contact us at Paramount Real Estate Services. 1008 12th St. SE Salem, OR 97302 503-851-1645
Also, to mobilize us right away to help you move, visit us here: