Tax Reasons to Keep Good Records of Home Improvements

How and why to document home improvements to the IRS.

By , J.D.

"Basis" is an important tax word that every homeowner should know. It simply means the monetary value of a property for tax purposes. To determine whether you realize a gain or incur a loss when you sell property, you start by subtracting its basis from the sales price. Thus, the greater your basis, the less capital gains tax you'll potentially have to pay when you sell your home.

You simply can't know whether you've had a gain or loss after you sell property unless you know its tax basis. For example, if your home has a $500,000 basis and you sell it for $750,000, you have realized a $250,000 gain.

Whether you actually owe taxes depends in part on the amount of the gain. If, for example, you're a single taxpayer who qualifies for the $250,000 home sale exclusion, your entire gain is tax free.

On the other hand, if your basis in a home is $400,00 and you sell it for $750,000, you'll realize a $350,000 gain on such a sale. Even with the $250,000 exclusion, $100,000 of your gain would still be taxable.

So, do you know what your home's tax basis is? Just as important: Can you prove it to the Internal Revenue Service (IRS)?

Three Elements of Tax Basis in Real Estate

Your home's tax basis has three elements that you must combine in order to determine its adjusted basis when you sell or otherwise dispose of the property.

Original Cost to Purchase the Property

If you've purchased your home, your starting point for determining the property's basis is what you paid for it. This includes the purchase price, as well as closing costs such as settlement fees, appraisal fees, legal fees, transfer taxes, title insurance premiums, credit report fees, property inspection costs, and any amounts owed by the seller that you agreed to pay.

Improvements You've Made to the Property

The cost of any improvements you make to your home while you own it are added to its basis. This reduces the amount of gain you'll realize when you sell the property.

Improvements are more than everyday home repairs, such as painting or replacing a cracked window or a few roof tiles. They include any work done that adds to the value of your home, increases its useful life, or adapts it to new uses. These might include, for example, room additions, new bathrooms, decks, fencing, landscaping, wiring upgrades, new walkways or driveways, kitchen upgrades, plumbing upgrades, and a new roof. Restoring damaged property with something new or like-new also counts.

In addition, assessments for items that tend to increase the value of your property, such as streets and sidewalks, should be added to its basis.

Other Basis Adjustments

Certain other items must be subtracted from your basis, which increases any profit you realize when you sell the home. These include:

  • insurance reimbursements for casualty losses
  • deductions you took for casualty losses that weren't covered by insurance
  • deferred gain(s) on home sales before 1998, and
  • depreciation claimed after May 6, 1997 if you used your home for business or rental purposes.

Proving Your Property's Tax Basis to the IRS

You need to document each element of your home's tax basis. The original cost can be documented with copies of your purchase contract and closing statement.

Improvements should be documented with purchase orders, receipts, cancelled checks, and any other documentation you receive. The records homeowners most often lose are those for improvements, so take special care to keep track of these. It's a good idea to list them all in your records with a running total.

You should keep all improvement-related records for as long as you own the home, plus at least three years after you file your tax returns for the year of the sale. Also, you should keep copies of all your tax returns forever.

But if you sold a home before May 7, 1997, and postponed tax on any gain, the basis of that home affects the basis of the new home you bought. This means you need keep records proving the basis of the prior home or homes for as long as you postpone your gains.

Especially if you plan to live in your home for many years, you should take care that your basis records are not lost, destroyed, or misplaced. You might wish to keep them in a safe deposit box with your other valuable records. Another alternative is to make digital copies of the records and store them online.

More Information on Tax Basis

For more on the subject of figuring gain or loss and determining basis, see IRS Publication 523, Selling Your Home.

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