Home Improvements: Save Your Receipts for Tax Savings

When most people think about making improvements to their home, they think about choosing the right finishes, flooring types and paint colors. Unfortunately, many homeowners tend to neglect one of the most important home-improvement tasks: keeping track of their receipts.

What’s so important about saving this information, you ask? Besides giving yourself a valuable record, knowing the total cost of your home-improvement projects could save you money when selling your home, thanks to a certain tax rule.

Here’s what you should know about the rule, and why saving your receipts could result in significant tax savings.

What does the tax rule entail?
The tax rule allows you to add capital improvements to the cost basis of your home. For example, if you purchased your home for $200,000 and recorded $50,000 worth of capital improvements over the years, the cost basis of your home is $250,000. If you sell your home for $500,000, you have a capital gain of $250,000.

Most people can exclude from income up to $250,000 of gain for single filers ($500,000 for joint filers) on the sale of their personal residence. To qualify, you must meet two criteria: 1) You have owned and used your home two out of the last five years as your principal residence; 2) You have not sold a principal residence in the last two years.

It’s important to note that the rule applies only to capital improvements. By definition, a capital improvement increases your home’s value, whereas a non-eligible repair returns something to its original condition. A capital improvement must last longer than one year, and must prolong the life of the home or adapt it to new users. Also, the improvement must still be there when you sell. For example, if you installed new flooring 15 years ago and replaced it right before you listed your home, the flooring from 15 years ago wouldn’t count as a capital improvement.

What happens if you don’t keep your receipts?
If you had not recorded your improvements in the scenario described above, you would have recorded a gain of $300,000. And since $250,000 is the gain exclusion for a single taxpayer, your net capital gain would have totaled $50,000. Assuming you are in the 15% capital gain bracket, you would be paying $7,500 in federal taxes, plus state taxes.
Now, you are probably thinking that your house will never sell for a gain of $250,000 or $500,000. But you never know—if you live in your home for several years, the cost of home improvements can add up. The few extra minutes it takes to keep everything filed in one place could save you a great deal of money.

Do you own a lake cabin or a vacation home?
The same tax rule applies to your cabin or vacation home. Unfortunately, the gain exclusion of $250,000 for single filers ($500,000 for joint filers) usually does not apply, since you may have not used the home as your principal residence for two out of the last five years. For this reason, it’s especially important to keep receipts relating to any improvements you make to these types of homes.

Designate a “Home Improvement” folder for your receipts
After you choose your favorite finishes and paint hues, choose a suitable folder (or safe-keeping place) in which to save your home-improvement receipts. Even if you’re not sure if the improvement qualifies as a capital improvement, throw it in your trusty folder. You can always sort through them later if you sell your property for a gain.

Good luck with your home improvement projects, and remember—when it comes to saving receipts (and choosing a paint color, for that matter), it’s better to be safe than sorry!

Chris Powers, CPA, is an AEM Business Partner who specializes in helping businesses and nonprofits grow. You can reach Chris at 507.304.6828 or at christine.powers@aemcpas.com.