15 Mar Keeping Track of Your Capital Improvements
Many first-time homebuyers don’t understand why it’s so important to keep track of capital improvements to their home. Moreover, many buyers don’t even know the true definition of a capital improvement. At Fairway Independent Mortgage Corporation Montana, we’re happy to provide a quick guide to understanding the basics of capital improvements and how to make the most of them from a financial perspective.
Why keep track?
First let’s cover the why. When you or your heirs eventually sell your home, the taxes you owe are calculated off of the total profit you make on the sale. For most people, it won’t matter, because you can exclude up to $250,000 if you are single and up to $500,000 if you are married and filing jointly. However, if it does matter, you may be able to save thousands by simply keeping track of your capital improvements over the years.
How is profit calculated?
Profit is calculated as the amount for which you sell your home minus the cost basis of your home. The cost basis of your home is the amount you paid for it plus any capital improvements you have made over the years. So, a higher cost basis can dramatically lower your total profit and the amount the IRS requires you to pay.
What is a capital improvement?
Generally, the IRS considers a capital improvement to be anything that increases the tangible value of your home. Homeowners often don’t really know what that means, however. Painting a room a more inviting color or replacing that worn carpet in the living room certainly feels like it adds more value to a home. But it wouldn’t pass the capital improvement test. That’s because, in both cases, it only returns the room to its original state, despite it being painted or carpeted. If I fix a door or roof, it is a repair, but if I replace either, it is a capital improvement. Exceptions to this are fire, floods and other natural disasters in which all work to restore your home to its original state is considered a capital improvement.
What should I do as a new homeowner?
To avoid confusion, the best policy as a new homeowner is just to keep notes and records on all repairs and improvements, and when the time comes to sell, you will have all the information that you may need to establish your cost basis.
Here’s a quick example to show why it is financially important. Imagine you are single and buy your home for $150,000. Over the 15 years you live in the house, you make several improvements (finishing a basement and adding a new room and a deck) totaling $35,000. The market is up, and you sell your house for $425,000. If you tracked your improvements over the years, you would owe no capital gains tax because the sale price ($425,000) minus the cost basis ($150,00 + $35,000) is less than the $250,000 exemption for your filing status. But if you didn’t track your improvements, you would owe long-term capital gains tax on $25,000 ($425,000 – $150,000 – $250,000), which is the amount over the exemption for your filing status.
A little record keeping along the way can save a lot of money over the long-term, and our Loan Officers are here to answer any further questions you may have. Give us a call today!