With the warm weather upon us, the home renovation season is in full swing, and clients often have questions about how to finance their projects and the tax implications. A common question about primary residence improvements is: What can I deduct? As with any tax answer, it usually starts with ‘it depends’. More often than not, the home improvement projects fall under the IRS code as a type of property that is personal to you and does not have a benefit to you in the tax code. In short, the IRS treats many of these projects as hobbies to improve your own standard of living. However, exceptions do regularly come up and can impact your decisions. Within limits, mortgage interest incurred to buy, build, or substantially improve your home can be used as an itemized deduction. Meaning, the $100,000 pool or kitchen remodel is not a deduction, but the interest on the secured loan used to pay for it may be which would be considerably less than the project cost. There can also be some exceptions to this rule; if you are self-employed and using the business use of home deduction, then a portion of the improvement could be used as a deduction against the income of that business. For example, if your office is 10% of the square footage of the home, then you may be able to deduct 10% of the home project, but there are considerable rules and limits that can be phased out based on the level of net profit from the business. Furthermore, a sale of the primary residence can result in recapture of depreciation taken for the home portion of business expenses.
Any costs to buy, build or improve a primary residence can increase your tax basis of the home. The $100,000 pool or kitchen install increases the tax basis and potentially reduces any gain from a sale of the home. It is good practice to keep a permanent file and make notes of property improvements that increase the tax basis in case of a future sale.
There is also a residence gain exclusion provided by the IRS assuming you have lived in the property two of the last five years. A single person could exclude up to $250,000 in gains and a joint filer could exclude up to $500,000 in gains, these amounts are not adjusted for inflation with the tax code.
A common project we get questions on is the installation of solar equipment. The direct cost of the equipment is not a deduction, although the interest could be deductible if the project were financed. However, the Inflation Reduction Act of 2022 extended solar tax credits up to 30% of the cost through 2033. The credit then drops to 26% in 2033 and to 24% in 2034. So, there may be some tax breaks to lowering your monthly energy bill. If you are considering installing solar, we recommend getting multiple quotes and discussing the numbers with our office. The national and local energy prices can fluctuate a lot which changes the breakeven time when considering the total cost of the project and the tax credits. Also, each utility company has specific net metering rules on how much benefit you can receive when ‘selling’ energy back to the grid. It is often limited in newer agreements, and most people do not reduce their energy bill down to $0.
We have had some clients asking about installing Electric Vehicle (EV) charging stations at home. There is a 30% credit for most installs with a cap of a $1,000 tax credit. There are also some odds-and-ends projects like installing energy-efficient windows, gas heaters, insulation, etc. The most important thing to know here is those credits often come with a lifetime limit for tax credits ($200 for windows, $500 in total). Please be aware of aggressive sales tactics about energy credits related to these projects and appliances, as they often do not impact the tax return in a material way.