With the house prices continuing to increase, taxes are on the minds of most sellers. When it comes to home ownership taxes, it’s important to understand the tax basis of your primary home.
Tax basis on your home is generally your cost in acquiring your home plus the cost of any capital improvements you made, less casualty loss amounts and other decreases.
Why Is Tax Basis for Your Home Important?
Because most home ownership costs—aside from real estate taxes and mortgage interest—can’t be deducted currently.
Yet, many of these home ownership costs will increase your basis, or cost for tax purposes, in the home.
If part of your home qualifies as a home office or is rented, a higher basis translates into a larger annual depreciation deduction.
Higher Basis Can Save on Taxes When You Sell Your Home
A higher basis can save you tax dollars when you sell your home.
The law allows an exclusion from income for part of the gain realized on the sale of one’s home. The exclusion limit is $250,000 ($500,000 for most married taxpayers).
Some commentators feel that the amount of the exclusion makes keeping track of the basis in the home relatively unimportant. Most homes today are sold for less than $500,000, and even fewer are sold for a gain approaching that amount.
However, that reasoning fails to take into account what is likely to happen to property values in the future.
If history is any indication, a home that is kept for 20 or 30 years may easily appreciate in value five or 10 times from its current value.
Under this scenario, a home that costs $200,000 could be worth well in excess of $1,000,000 by the time it is sold.
That’s why you’ll want your basis to be as high as possible; you can avoid or reduce the income tax that may result when you eventually sell your home.
Calculating the Tax Basis of Your Home
Accurate recordkeeping is key.
You’ll need to keep accurate records of:
- Home purchase price
- Home purchase closing costs and other expenses
- Any other expenses that increase your basis
- Save receipts and other records for all improvements and additions you make to your home.
The key element in determining the basis of your home is the purchase price. This includes:
- Down payment
- Any debt, such as a bank mortgage or notes you gave to the seller in payment for the property
- Certain settlement or closing costs
Since this process is likely to continue for a long period, you should keep these documents together with a summary list that you can use to easily determine your home’s tax basis at any time.
Basis for Your Home: Gain or Loss
When you eventually sell your home, your basis will establish the amount of your gain. The supporting documentation should be kept for at least three years after you file your return for the sale year.
Other home expenses paid in connection with the purchase of your home can be added to your cost basis, including:
- Attorney’s fees
- Abstract fees and owner’s title insurance
- Recording fees and transfer taxes
However, the following settlement fees or closing costs can’t be added to your basis:
- Fire insurance premiums
- Rent or charges for utilities or other services relating to your occupancy of the house before closing
- Charges connected with obtaining your mortgage, such as credit and appraisal reports, and FHA insurance.
The basis of your home is increased by special assessments for local improvements and amounts spent after a casualty to restore damaged property.
Tax Basis for Having a Home Built
If you contracted to have your house built on land you own, your basis is the cost of the land plus the amount it cost you to complete the house.
The tax basis for building a home includes:
- Cost of labor and materials
- Amounts paid to the contractor
- Any architect’s fees, building permit charges, utility meter and connection charges
- Legal fees directly connected with building your home
If you built all or part of your house yourself, basis includes the total amount it cost you to complete it.
Basis doesn’t include the value of your own labor, or any other labor you didn’t pay for.
However, if the value of your home increases because of unpaid labor, including your own, any such increase that is realized when you sell your home may be eligible for the homesale exclusion (assuming that you otherwise meet the requirements for the exclusion).
Home Improvements that Increase Basis
As you make additions and improvements to your home, you can add the cost of these improvements to your basis.
Typical improvements that add to your home’s basis include:
- Room additions (for example: a den, bathroom, bedroom, patio, deck or garage to your home)
- Finishing the basement
- New landscaping, sprinkler system, and fences
- New heating or central air conditioning system
- New roof or new plumbing or wiring
- Installing storm windows or doors, security system, central vacuum, or satellite TV dish
- New flooring or wall-to-wall carpeting
- Paving the driveway
Decreased Basis on Your Home
If you sold a previous home and were able to defer the gain under the rules that applied to a sale or exchange of a principal residence before May 7, 1997, the amount deferred reduces your basis in the new home.
The basis of your home is also decreased by:
- Depreciation allowed or allowable if you used your home for business or rental purposes
- Insurance reimbursements for casualty losses, as well as deductible casualty losses not covered by insurance
- Payments received for an easement or right-of-way that you grant
- Any energy conservation subsidy excluded from your gross income
Home Repairs vs. Home Improvements
Home repairs are expenses that don’t add much to the value or the life of the property, but instead keep the property in good condition. Unlike home improvements, you can’t add home repairs to the basis of your property.
Home repairs include:
- Interior or exterior repainting
- Fixing gutters or floors
- Repairing leaks or plastering
- Replacing broken window panes
However, an entire job is considered an improvement if items that would otherwise be considered repairs are done as part of extensive remodeling or restoration of your home.
The cost of appliances you purchase for your home generally don’t add to your basis unless the appliance is considered attached to the house.
Example: The cost of a built-in oven or range would increase basis. But an appliance that can be easily removed—like a television set or home entertainment center—would not increase basis.
If you have questions, reach out to us at 314-961-1600 or contact us to discuss your situation.
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Alan Dierker is a Tax Manager with experience in tax, outsourced controller services, including fulfilling compilation and preparation agreements, payroll and compliance issues. He also has experience in the following industries: Wholesale Distribution, Private Foundations, Not-for-Profit and Real Estate.
About Smith Patrick CPAs
Smith Patrick CPAs is a boutique, St. Louis-based, CPA firm dedicated to providing personal guidance on taxes, investment advice and financial service to forward-thinking businesses and financially active individuals. For over 30 years, our firm has focused on providing excellent service to business owners and high-net worth families across the country. Investment Advisory Services are offered through Wealth Management, LLC, a Registered Investment Advisor.