For those of you who own homes, you are probably making plenty of home improvements… if so, you’ll want to read on.
Each time you make home improvements, it increases your basis in the home. This new basis becomes your “adjusted basis”. Three times which it is important to know your adjusted basis are:
1. When you SELL your home – To determine you Gain or Loss.
2. When you RENT your home – To determine depreciation as well as capital gains tax
3. When you have a HOME OFFICE – To determine your depreciation for your office.
Your adjusted basis is used to determine your GAIN or LOSS on your primary residence when it is sold. Fortunately, if you file single you get to exclude up to $250k of income on the same (if Married Filing-Join you can exclude up to $500k).
When you rent, you need to know your adjusted basis to determine how much you can depreciate, as well as determine the amount of income from the sale to figure your Capital Gains tax. The topic of capital gains tax is what drove me to write this article. Currently, I have a client who bought his home for $67k. He said he made roughly $100k in home improvements, but he only has records of $20k. Unfortunately for him, this means that he will have to pay Capital Gains Tax on an ADDITIONAL $80k solely because he does not have the statements to prove the cost of the home improvements he made. That could cost him $12k additional in taxes when he sells the home… OUCH!
Finally, just as you need to know the adjusted basis to determine depreciation on your rental, you need it to figure your Home Office deduction.In conclusion, KEEP ALL RECEIPTS for home improvements on your home in a marked folder and file them away. On each receipt, I would write the name of the project on the receipt as well. That way, when you need to determine your adjusted basis on your home (and that time will come) it will be really easy to do. There is no better way to prove to the IRS your adjusted basis than with these receipts.
Without them, and if audited, it is not likely the IRS will recognize your home improvements and could open you up to back taxes owed as well as any assessed penalties for “overdue” taxes.