Capital Improvements: 6 Tax-Deductible Home Improvements

In the United States, a capital improvement refers to any renovation that adds value to a property, extends the property’s “useful life,” or adapts the property for other uses. Within certain limitations, capital improvements can offer favorable tax deductions or tax credits for property owners—the most common situation is when capital improvements work together with the principle of capital gains to reduce taxable income during the sale of the property. According to the IRS, a capital improvement must be durable or permanent and stand for at least one year to qualify for any tax-related benefits.

Less-common examples of home improvement projects that can offer favorable tax breaks, exemptions, or write-offs include renovations for energy efficiency, like solar panels, fuel cells, geothermal heat pumps, solar water heaters, wind turbines, or other renewable energy options. Improvements that are a part of medical expenses (like ADA accessibility ramps or handrails) also qualify for this tax break. If you use your home as a business, you may be able to deduct the depreciation from your cost-basis (the initial amount you paid for the property) on your tax return. In corporate finance, the principle of capital improvements is similar to capital expenditures.

In homeownership, capital improvement projects work by increasing the cost basis of a property:

1. 1. The buyer purchases a property. Before you can initiate any capital improvements, you must first buy the property. The home’s purchase price will be necessary for factoring in capital improvements.
2. 2. The buyer performs qualifying capital improvements. After purchasing the property, complete the capital improvements, such as a new heating system, solar panels, or an additional bedroom. It’s important to carefully track the improvement costs, keeping itemized receipts and other paperwork. The IRS adds the costs of these capital improvements to the property’s purchase price (also called the “cost basis”).
3. 3. The buyer sells the property. Once the capital improvements are complete, you may decide to sell the property. When you do, the principle of “capital gains tax” comes into effect on your income tax returns—any profit you make on the home sale is taxable by law. However, if you have made capital improvements, the cost basis of your home has increased, which decreases the size of your taxable capital gains, which can help you save money at tax time. For instance, if you purchased your home for $200,000, made $50,000 in capital improvements, and sold it for $300,000, your taxable capital gains would be $50,000, rather than $100,000. (It’s important to note that in real estate, capital gains are subject to additional regulations—for instance, they may be tax-free if under $250,000 or if the property has served as your primary residence for at least five years. Always consult a tax professional for the most detailed and up-to-date information for your area.)

While both capital improvements and home repairs are a way to improve a property, they differ based on necessity. Capital improvements are optional, permanent renovations that add value (such as adding a bathroom or installing a satellite dish). Repairs are required (or highly recommended) fixes that usually fall under general maintenance of standard wear and tear (such as repainting walls or replacing broken window panes).

According to the IRS, capital gains must be durable or permanent and either increase the value of your home, extend its useful life, or adapt it to new uses. Here are examples of common capital improvements:

1. 1. Architectural additions: Adding new rooms—including bedrooms, bathrooms, home offices, or other facilities—to a property is a permanent improvement that can increase its value, which typically falls under the capital improvement umbrella.
2. 2. Certain interior renovations: Many interior home renovations (like repainting or buying new drapes) don’t qualify as capital improvements because they are routine maintenance expenses. However, some permanent interior renovations fall under a capital improvement plan (CIP), including major flooring renovations, fireplace changes, kitchen refurbishments, and adding built-in appliances.
3. 3. Exterior renovations: Exterior renovations that can count as capital improvements include a new roof or shingles, new siding, and new storm windows and doors.
4. 4. Home systems: New home systems are major capital improvements that increase the value of the property. Examples include plumbing or septic systems, water or air filtration, heating, central air conditioning, HVACs, furnaces and ducts, central humidifiers, water heaters, soft water systems, and security systems.
5. 5. Insulation: Installing new insulation throughout the home, including pipes and ducts, can qualify as a capital improvement.
6. 6. Landscaping: Outdoor changes like new landscaping, renovated driveways, or swimming pools count as durable, value-adding capital improvements.

All investments, including real estate investments, come with inherent risks which may involve the depreciation of assets, financial losses, or legal ramifications. The information presented in this article is for educational, informational, and referential purposes only. Consult a licensed real estate or financial professional before making any legal or financial commitments.

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