Deducting Home Improvements

EP 53 - Deducting Home Improvements

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Welcome and thank you for joining us on our tax talk Thursday show where we dig deep into tax. And my goal is to provide you some ideas to help you save on those taxes.

Well, we asked for your questions and on today's show, we have a great one.

 I was listening to your show the other day and you said to send in your questions. So here is what I have. My wife and I are considering doing some home improvements. And one of the contractors told us that we can take a deduction on our taxes for the money we are paying for these upgrades. But when I did a search on the internet, it seems that [00:01:00] this may not be true.

I am really confused and need your help. Can you please explain this so my wife and I can make an informed decision? I am trying to stay financially savvy and follow you. Thank you, Ralph, and God bless you. Oh, by the way, my name is Howard, and I'm located here in Jacksonville, Florida.

This is a great question. And honestly, a question I get quite often here at my accounting practice.

So let's address that issue today.

But before we dive in, let me ask you this. Have you ever wondered why you can't take an immediate tax deduction for home improvements? You make.

I mean, you invest hard earned and money and upgrading your property.

So shouldn't you be able to reap the tax benefits right away? Well, my friends, today, we're going to uncover the reasons behind this rule. And explore what happens to those expenses. If you can't use them.

 So before we dive in, let me remind you of this. You can reach all of our show notes at askralphpodcast.com and the best part is you can also schedule a consultation with me.

You go to askralphpodcast.com/store. And you can schedule an in-person or

zoom meeting, and I can [00:02:00] help you on your taxes. Or on any other financial situation you find yourself in. So let's get to the topic of the day.

 so to of understand why you can't deduct home improvements in the year you do them.

We need to first grasp, the concept of capital improvements.

So you might ask Ralph, what are capital improvements?

Well, I'm going to give you an answer. They are enhancements that add value to your property. Prolong its useful life, or adapt it to new uses. These improvements can range from renovating your kitchen or bathroom to adding a new room or installing a swimming pool, even. Well, they certainly make your home more comfortable and enjoyable. They differ from regular repairs or maintenance.

You know, these aren't the issues where, we had to get something fixed. we had a hole in the roof and we had to get that repaired or we had a sidewalk crack and we had to get new concrete put in. These are definitely what we call capital improvements. And like I said, the key to this. Is they add value to your property? they prolong its useful life. or adapt it to new uses.

Now the main reason you can't deduct these expenses immediately is [00:03:00] because they're considered capital expenditures. And capital expenditures are addressed directly into tax law the tax law treats capital expenditures differently from regular expenses because they provide long-term benefits. They contribute to the overall value of the property. So instead of allowing you in immediate tax deduction, the internal revenue service requires you to capitalize these costs. And recover them over time through depreciation, or when you sell your home.

Now, before we get too deep into the weeds. If you own a rental property, the way you're going to treat this as little differently. So I'm going to be doing a podcast coming up about rental properties and expenses. But for today , we're going to talk about simply about this is your personal residence. So, how does this work?

 you're asking me, Ralph, what does this mean? Well, when you make a capital improvement, like adding a bathroom, improving your kitchen, adding a room or something like that.

You must add the cost of that improvement to the basis of your home. Now, a lot of people come in and meet with me and they say, Ralph. What in the world is basis.

Let me explain this. [00:04:00] This is a vital concept to understand. When you buy your house originally, whatever you paid for your house, plus all the closing costs. Is what we call basis. It's basically the foundation of what you paid for the house. When you add improvements or you make, major renovations or your do things like that adds to the basis. So again, the basis is the amount of money you paid for the home. Including any additional costs such as closing fees or legal expenses.

It's really important that you know what that is. Because at some point, if you ever sell your home, I'm going to ask you that question. Or when you go to do your taxes, you're gonna need no, that question. So by increasing your basis, you effectively reduce the amount of gain you'll have when you sell the property in a future. let me make a simple example.

So let's say that you bought a home for $200,000. And I'll say you bought that home in 2002. And, coming along 2004, and maybe you were, refinished the basement, let's say you spent $50,000 on refinishing the basement. So now your basis is 200,000. Plus the 50,000 you [00:05:00] put in renovations. So let's say 2024 comes around.

You said, you know what? I think it's time to sell. Well, your capital gain is going to be the difference between your sales price. Now that's a net sales price. After you pay your closing costs and you pay for the realtor and the attorney and all that sort of thing. Whatever that difference is between that sales price and that. Quote adjusted basis is going to be what your capital gain. Is based on.

So in our example, You pay $200,000 for the house you added $50,000 worth of home improvement. So now we're at $250,000, that's our basis. And let's say you sell the house for 300,000 net. All the expenses. So your capital gain will be simply 300,000 minus the $250,000 basis. So you have a $50,000 capital gain.

Well, right now, The way taxes are structured. If you're single. You can exclude up to $250,000 of gains, or if you're married, you can exclude up to $500,000 gain. So that's why this is so important to understanding this basis because if tax laws change. And they reduce the amount of the exclusion, [00:06:00] or if let's say, you've had the property for 30 years and it's really appreciated and value might be close to that where you might have to pay capital gains tax. So let's address the second part of the question. So what happens to those expenses?

If you can't use them? Let's say you made substantial improvements to your home and you're unable to deduct them for due to limitations or insufficient taxable income. Now, there are things that you can deduct right away. Those are energy credits and I'll handle those in another podcast. Well, fear, not, because these unclaimed expenses carry forward, just like we talked about and become part of the homes adjusted basis.

And like I said, this means that when you eventually sell your home, You can use those unclaim expenses to reduce your taxable gain. It's kind of like a hidden treasure, my friends waiting for you in the future. So, even if you can't benefit from the immediate deduction, you can still recoup those expenses. And potentially low your tax liability when you sell the property. So. The question that was asked by Howard was. Contractor said to them, listen, I'm going to do some improvements to your house.

 you can write those off on your taxes. And unfortunately, I hear this all the time. It's sad. [00:07:00] These are not well-educated contractors or they're just being, inappropriate and telling people lies. So to answer Howard's immediate question is no, you can't deduct those right away, but they do become basis things.

However, it's important to note that not all improvements are eligible for this capitalization and subsequent depreciation. The IRS has specific guidelines regarding what qualifies as a capital improvement. Here's what those general guidelines are. The improvement must enhance the value of your home. It's gotta be considered permanent in nature. And have a useful life of more than a year. So for example, Let's say you decide to renovate your bathroom. Well, clearly. That is going to enhance the value of your property. and enhance the value of you home? It's considered permanent. In nature.

You're not going to take it down once they're done. And this has a useful life of more than, or clearly you can use the bathroom for more than a year. So I'm going to say this. I say this in all my podcast. It's always best to consult with a qualified tax professional review, the IRS guidelines to [00:08:00] ensure you're following the correct procedures.

And that's why I sent you to the askralphpodcast.com/store. Where you can actually schedule a consultation with me. It doesn't matter where you live. I have clients all over the world. Zoom has made this a way that we can talk to anybody wherever they are. So if you feel like they'd be a good fit for you, like I said, go to askralphpodcast.com/store. And there you'll see a place to book a consultation with me.

So let's talk about some examples of what are typical home improvements that the IRS puts in their guidelines.

We talked about this one a few minutes ago, like adding a room or additional level to your home, if you decide to take the roof off and put a second floor on. Clearly that is a home improvement. Renovating or expanding your kitchen.

Upgrading your bathroom. Like we talked about, we can also talk about adding new fixtures, tiles, or even a jacuzzi. tub.

If you're into that. Installing a new heating, system, ventilation, system,

our HVHC system that would also qualify as a capital improvement. Installing a new roof or

redoing your signing. How about building a garage or adding a

car port? If you construct a new deck, if [00:09:00] you construct a patio, or a porch,

all those count as, capital improvements, installing a swimming pool or a hot tub.

Hey, those are great capital improvements. And if you do that, give me a call. I'll come over. You can also add fencing, or do landscaping improvements.

And finally, and this is not a complete list, upgrading electrical wiring or plumbing systems. So if you find that your electrical system or your plumbing system is starting to age. The replacement or upgrade of that is considered a capital improvement.

Now, like I said before, it's important to note that these examples are general in nature. These. These are really broad based things. And whether an improvement qualifies as a capital improvement depends on specific criteria set by the IRS. Now they can also think about things like. The nature of the improvement, its permanence. And it's impact on the value and use life of the home.

It's always advisable to consult with somebody. So again, I'm going to say that.

Well, that brings us to the end of this episode of the ask Ralph podcast. I hope you enjoyed our discussion.

So let's recap.

Today, we uncovered the reasons why you [00:10:00] can't deduct capital improvements to your home in the year.

You do them and explore what happens to the expenses. If you can't use them, remember, capital improvements are longterm investments in your property. And while you may not see immediate tax benefits. In the long run, they do contribute to reducing your taxable gain. When you sell your home.

So again, I'm remind you to visit our podcastPage@askralphpodcast.com or you can leave us a review.

You can leave a message. like Howard did and we'll answer it in one of our future shows. We love hearing from our listeners. So again, as I always say, thank you for tuning in. God bless, you. And always like Howard said, Stay financially savvy.

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