Many taxpayers don’t feel the need to keep home improvement records, thinking the potential gain will never exceed the amount of the tax code’s exclusion for home gains. However, during all the chaos and excitement, it’s essential not to overlook the importance of keeping home improvement records of your projects. Below, we will explore why maintaining accurate home improvement records is crucial and the benefits it can offer in the long run.
Under the current tax code, you are allowed an exclusion of up to $250,000 ($500,000 for married couples) of gain from the sale of your primary residence if you owned and lived in it for at least 2 of the five years before the sale. You also cannot have previously taken a home-sale exclusion within the two years immediately preceding the sale. There is no limit on the number of times you can use the exclusion if you meet these time requirements. However, extenuating circumstances can reduce the amount of the exclusion. The home-sale gain exclusion only applies to your main home, not a second home or a rental property.
As noted above, you must have used and owned the home for 2 of the five years immediately preceding the sale. The years don’t have to be consecutive or the closest to the sale date. Vacations, short absences, and short rental periods do not reduce the use period. If you are married, to qualify for the $500,000 exclusion, you and your spouse must have used the home for 2 out of the five years before the sale, but only one of you needs to meet the ownership requirement. When only one spouse in a married couple qualifies, the maximum exclusion is limited to $250,000 instead of $500,000.
If you don’t meet the ownership and use requirements, there are some situations in which a prorated exclusion amount may be possible. For example, if you were required to sell the home because of extenuating circumstances, such as a job-related move, a health crisis, or other unforeseen events. Another rule extends the five years to account for the deployment of military members and certain other government employees. Please call our office if you have not met the 2 out of 5 rule to see if you qualify for a reduced exclusion.
But what if your home sale gain exceeds the home sale exclusion? Then it is in your best interests to keep home improvement records. Even if only saving the receipts for the improvements in a folder or a shoe box.
Why Keep Home Improvement Records
Here are some situations when having home improvement records could save taxes:
(1) The home has been owned for a long time, and the combination of appreciation in value due to inflation and improvements exceeds the exclusion amount.
(2) The home is converted to a rental property, and the cost and improvements of the house are needed to establish the property’s depreciable basis.
(3) The home is converted to a second residence, and the exclusion might not apply to the sale.
(4) You suffer a casualty loss and retain the home after making repairs.
(5) You sell the home before reaching the 2-year use and ownership requirements.
(6) The home only qualifies for a reduced exclusion because the house sold before meeting the 2-year use and ownership requirements.
(7) One spouse retains the home after a divorce and is only entitled to a $250,000 exclusion instead of the $500,000 exclusion available to married couples.
(8) Future tax law changes could affect the exclusion amounts.
Everyone hates to keep records but consider the consequences if you have a gain and can’t exclude a portion. You will have capital gains (CG), and there is a good chance the CG tax rate will be higher than normal simply because the gain pushed you into a higher CG tax bracket. Before deciding not to keep records, carefully consider the potential of having a gain more than the exclusion amount.
Home improvements include anything that will increase the home’s value. For example, big-ticket items include swimming pools and landscaping to smaller things like ceiling fans. But there are some home improvements that you can’t have in the cost of home improvements. Those include items that qualify for tax credits, such as home solar or home energy efficiency improvements, or those that are eligible for a tax deduction, such as handicap improvements.
If you have questions about the home gain exclusion or how keeping home improvement records might directly affect you, please get in touch with FSL Tax and Accounting Services. Call us at 678-702-7218 for a free consultation, or complete the online form to understand why you should be keeping home improvement records.