In the past, many homeowners didn't give much thought to keeping detailed records of home improvements. With capital gains exclusion thresholds of $250,000 for single filers and $500,000 for married couples, most homeowners didn't come close to exceeding these limits when selling their homes.
As a result, they often overlooked the importance of tracking and documenting their expenditures on property improvements. However, the landscape has shifted significantly in the last decade.
The rapid appreciation of home values has pushed many homeowners into a position where they might exceed the capital gains exclusion threshold and owe taxes on their profit. By understanding what qualifies as a capital improvement and maintaining accurate records, homeowners can increase their adjusted basis, thereby reducing their taxable gain when selling their property.
What Counts as Capital Improvements?
Capital improvements are expenditures that add value to your home, prolong its useful life, or adapt it to new uses. These are not limited to big-ticket items like kitchen remodels or room additions, installing energy-efficient windows, replacing a roof, or upgrading HVAC systems.
Even landscaping improvements, building a deck, or adding a fence can qualify, as well as replacing a faucet, adding a video doorbell or other smart devices in the home. The key is that these improvements must be permanent and add to the property's value.
Why Keeping Records Matters
Every dollar spent on a capital improvement adds to the cost basis of your home. The cost basis is used to calculate your capital gain, which is the difference between your home's net sale price and its adjusted basis (original purchase price plus improvements). By increasing your cost basis, you can reduce the taxable portion of your profit, potentially saving thousands of dollars in capital gains taxes.
To maximize these benefits, it's crucial to keep receipts, invoices, and other documentation for all qualifying expenditures. Create a folder—physical or digital—to organize these records and ensure they're readily available when it comes time to sell your home.
Why This Matters Now
In the last decade, home prices have appreciated at an unprecedented pace. Inventories are smaller and demand is high causing the prices to increase. This rapid growth means more homeowners may find themselves exceeding the capital gains exclusion thresholds.
By properly documenting capital improvements, homeowners can mitigate their tax burden and retain more of their hard-earned equity. As home prices continue to rise, understanding and utilizing these strategies has never been more important.
For more information, consult your tax professional and download our Homeowners Tax Guide or IRS Publication 523.