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How Improving a Home Can Improve Your Tax Situation

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It's summer and that usually means one thing for millions of Americans: Home Improvement Time. From painting, to yard and landscape improvements, to full-blown home renovations and additions, summer is the time when many homeowners work to spruce up or just maintain their residences. Aside for increasing your home's value (not to mention your personal satisfaction), did you know fixing up your home can help lower any future tax liability?

The tax rules regarding home improvements are fairly complex. There are also several benefits to claim, ranging from deductions for home purchase sales taxes to credits for making select energy-efficient improvements. In addition, you may be able to increase the cost basis of your home, a calculation that is determined by taking the original cost of your home plus any improvements made and less any energy or first-time homebuyer credits and casualty losses you can claim. The basis can help to reduce future gain and future tax exposure when it comes time to sell.

But before we look at what you can do to help save on taxes, we need to clear up how the IRS defines a home repair and a home improvement for tax purposes.

The terms "repairs" and "improvements" can be confusing as they are used regarding taxes and application to the value of your home, and each one has different implications. A repair or maintenance expense that fixes or simply maintains a part of the home is not tax deductible and cannot be added to the basis of your home, so there is no tax benefit here.

Yet a home improvement is much more of a tax benefit, because it adds to the value of your home and can then be added to the basis. For example, adding a new roof, an energy-efficient window or door, hot water heater, or even a new room are all considered improvements, as is landscaping. However, repairing a broken water pipe, fixing a leak in a roof with a patch, or painting your home would be a repair and not added to the basis, as these expenses are not tax deductible. While you own your home, keep a record of the cost of improvements you make that add value, such as landscaping, patios, swimming pools, decks, room additions and roof replacements.

When it comes time to sell, subtract the cost basis from the sale price to determine any gain. Currently, only the first $250,000 in gain ($500,000 of married filing jointly) is exempt from being taxed. Any gain above that may be subject to income taxes.

There are different rules for repairs or improvements made on a rental property, since repairs done on the rental home are a direct deduction against your rental income for the year. Any repairs done will be depreciated (using a prescribed formula) over a pre-determined useful life span based on tax rules. Depreciation allows you to deduct a percentage of the improvement each year and recapture the out of pocket cost as a benefit on the tax return. When you sell a rental property, you must subtract any depreciation you claimed to your basis and then determine your gain or loss on the sale.

The home is typically the largest single asset most taxpayers own, and it's often the one that takes the most work to keep in the best shape possible, in terms of both time and money spent. While you can't get time spent on home improvements back, you can often get some of your dollars returned either at tax time or when you sell, provided that you track of all of your costs as you own and work on your home. By having your receipts on hand, down the road when you sell your home, you can avoid hitting a big tax gain -- and a substantial tax bill. Like many things, a little time spent preparing now can help you enjoy the tax benefits in the future.