Tax planning involving your primary residence is a multiyear project that only begins when you purchase the home and only ends after you sell it. In the meantime, what changes to your home can help reduce your tax bill? Here's what you need to know.
Improvements Affect Your Final Tax Bill
Permanent improvements that add to the value of the home are known as capital improvements. This generally includes renovations of most types, adding a new roof, an updated water heater, or exterior decking, and putting in a swimming pool.
Capital improvements don't change your tax bill from year to year, but they do reduce taxes when you sell. How? These costs are added to the basis of the property, which is the total amount of money permanently invested in it as an asset. When you sell, the basis is deducted from your total sale price in order to calculate the taxable profit. The higher the basis, the better.
Updating Can Affect Your Annual Taxes
While the actual capital improvement may not directly lower your taxes, some improvements can be used in other ways. Energy-efficient upgrades, such as solar panels, geothermal energy, additional insulation, natural gas appliances, and energy-saving doors or windows — may qualify for targeted tax deductions.
In addition, the types of renovations may help boost deductions in other ways. For instance, if you add a space that will be dedicated as a home office, you may be able to begin deducting this cost every year. Or if the remodel allows you to rent out a portion of the home or run a home-based business, its costs may be deductible to offset business income earned.
How to Plan Ahead
The first key to using all home changes properly is to understand what can and cannot be used on your income tax forms and plan your repair or replacement choices accordingly. If an upgrade to an electric heat pump, for instance, could result in more value to the home and a tax credit, you may choose not to simply replace what you have.
Secondly, diligently keep track of all changes made to the property over the years. Even if you aren't sure if an expense can be added to the basis or deducted, keep records of it. Because tax laws change regularly, what may not be useful now could eventually become so — and vice versa.
No matter if you already own your home or you're planning to buy, the first step should be to consult with a tax service that offers IRS tax reduction planning services. They will help you make the best choices now to ensure you never get a surprise tax bill later.