When calculating how much your home has increased in value, you have to identify its COST BASIS – meaning anything and everything that you spent to pay for the product. The IRS defines a capital improvement as a home improvement that adds market value to the home, prolongs its useful life or adapts it to new uses. Minor repairs and maintenance jobs like changing door locks, repairing a leak or fixing a broken window do not qualify as capital improvements.
Capital improvements and things you can put in your COST BASIS include:
- The price you paid for the property, including settlement costs, such as: title fees, legal fees, recording fees, survey fees, and any transfer taxes or fees you paid in connection with the purchase.
- Additions: An added extra bedroom or bathroom, a deck on the back of the home, a new garage, an added porch or patio….anything that adds value to your home.
- Lawn and grounds improvements: Value-adding landscaping projects, driveway or walkway construction, a new fence or retaining wall, adding a swimming pool, etc can qualify as property improvements.
- Exterior improvements: New windows, a new roof, and new siding are examples. Any and all renovation costs including ANY and ALL costs related to that renovation work.
- Insulation: This includes insulation in the attic, inside walls, under floors, or around pipes and ductwork.
- Systems: Installing a new heating or air conditioning system, new ductwork, adding a central vacuuming system, wiring improvements, installing a security system, solar, geothermal, generators, batteries, and putting in lawn irrigation are improvements.
- Plumbing: Installing a septic system, water heater, or soft water system adds value.
- Interior improvements: New appliances, kitchen renovations, new flooring/carpeting, the installation of a fireplace, etc.
If you needed to make home improvements in order to sell your home, you can deduct those expenses as selling costs as long as they were made within 90 days of the closing. Your COST BASIS does NOT include hazard insurance premiums, moving expenses, or any mortgage-related charges (mortgage insurance, credit report fees, and appraisal costs are out) and general repairs that are essential to keep something working do not qualify. Yard maintenance, HOA fees, and real estate taxes don’t count. Always check with your accountant.
Keeping tabs of these costs throughout the lifetime of a house is wise.
How do you calculate the capital-gains tax when selling?
Subtract your COST BASIS, commissions, and closing costs from your sales price to determine the taxable gain. Those who lived in the home for two out of the last five years can also subtract the $250,000 exemption if single (or $500,000 if two people), and then the rest is the taxable amount. Long-term capital gains — that is, gains on assets held for a at least a year – are generally taxed at a lower rate than earned income (money that you get from working).
In 2022, the IRS ranges are as follows:
- 0 Percent – $0-$41,675 Single/$0-$83,350 Married
- 15 Percent – $41,676-$459,750 Single/$83,351-$517,200 Married
- 20 percent – $459,751+ Single/$517,201 Married
The State of California will take their chunk too. Check with your tax adviser!