That information could come in handy when you go to sell.
- Selling a home at a profit can trigger a tax liability.
- You can use the cost of home improvements to lower the sum you owe the IRS.
There are plenty of reasons you might choose to renovate your home. For one thing, doing so could improve your quality of life.
Say you have an unfinished basement, but your upstairs is loaded with your kids’ toys. If you spend the money to finish up that space, voila — instant playroom.
Renovations can also add value to your home, making it easier to command a higher price when the time comes to sell it. But if you’re going to make home improvements, it’s important to keep solid records of the amount you spend on them. Here’s why.
It’s all about minimizing your capital gains
When you sell a stock in a brokerage account at a price that’s higher than what you initially paid for it, you’re subject to capital gains taxes. Similarly, when you sell a home at a profit, capital gains taxes apply as well.
That said, as a homeowner, you’re 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 you owned and lived in your home for at least two years within the five-year period leading up to the sale of that property.
So, here’s how capital gains on a home sale might work. Let’s say you purchased your home for $300,000 and are selling it many years later for $900,000 jointly with your spouse. Normally, you’d be looking at $600,000 in capital gains. But because you can exclude $500,000, your tax liability is whittled down to $100,000 in capital gains. (To be clear, you wouldn’t owe the IRS $100,000 in that situation — you would simply pay taxes on that $100,000.)
Now, here’s where home improvements come into play. When calculating capital gains, you can include certain expenses in the cost of your home. These include real estate agent fees you incur in the course of selling your home, and they also include home improvements.
So, let’s say you bought your home for $300,000 but also spent $30,000 to finish your basement. Let’s also say you paid a real estate agent $45,000, …….