If you’re improving your home—say, putting in a deck or finishing a basement—a little forethought can provide some big tax savings.
Strategy: Keep detailed records of home improvements. The costs aren’t deductible, but you can add them to the home’s basis, thereby reducing the taxable gain on a future sale.
Good record-keeping helps maximize the benefits of the home sale exclusion. For a home owned and used as your principal residence at least two of the five years prior to its sale, joint filers can exclude tax on up to $500,000 of gain ($250,000 for single filers).
Example: You and your spouse bought your home 20 years ago for $400,000. In 2013, you add a swimming pool, patio and landscaping for $100,000. Then you sell the home for $990,000. Because your basis is increased by $100,000 your gain is $490,000, so it’s completely sheltered by the home sale exclusion. Without records, you would have been taxed on a $90,000 gain ($590,000 gain – $500,000 exclusion).
This is even more critical this year due to new tax increases and the Medicare surtax on investment income. For instance, assuming you must pay the maximum 20% capital gains rate plus the 3.8% surtax, you would owe $21,420 in tax on your gain (23.8% of $90,000).
Tip: Also maintain records of past improvements used to increase basis.