Capital Improvements to the Home

One of the most neglected and overlooked areas of record keeping has to do with capital improvements made to a person's principal residence. Part of the reason is that many people don't know what constitutes a capital improvement and another major part is not making enough effort.

The lack of effort comes from the fact that most homeowners know that as long as they buy a home more expensive than the one they're selling, the tax on the gain will be deferred. If it is deferred, then why make the effort.

The reason is that someday, you might not reinvest in another home or you may elect to take the once in a lifetime exemption, which in either case will trigger the calculation of the gain. One of the single most important areas of reducing gain is to accurately record the capital improvements made to a home during ownership.

Repairs on a principal residence are considered maintenance on the property. However, capital improvements can be added to the basis or cost of the property thereby reducing gain. There are three simple questions that can be asked to identify a capital improvement:

1. Does it materially add to the value of the residence? Examples might be the addition of a fireplace, new fixtures, a pool, or a spa.
2. Does it prolong the useful life of the residence? This applies to improvements that if not done would shorten the property's economic life, such as a new roof, exterior paint, or a new furnace.
3. Does it adapt a portion of the home to a new use? Converting a garage to a family room or finishing a basement or an attic would apply to this rule.