Dear Liz: We replaced our original, fire-vulnerable cedar shake roof with 40-year asphalt shingles 17 years ago. I know that home improvements are added to the basis for capital gains calculation when selling the home. But when we get ready to sell the home in a few years, should the actual cost on the project be used? Or, since it was several years ago, should we calculate what a “present value” of the 2007 dollar amount would be? For that matter, should the purchase price of the home be updated to a present value?
Answer: You don’t have to discount the costs of home improvements, but you also don’t get to boost your tax basis to reflect your home’s appreciation.
To review: Your tax basis is the amount you paid for your home, plus the cost of qualifying capital improvements — projects that added to the value of your home, extended its useful life or adapted it to new uses. The tax basis is subtracted from home sale proceeds to determine the potentially taxable capital gain. If you’ve lived and owned a home for at least two of the five years before the sale, you can exempt $250,000 of home sale profits per owner.
Keeping good records of your improvements has become increasingly important over the years, because that exemption amount hasn’t been updated since it was established in 1997. Back then, the median home sale price was less than $150,000 and most home sellers didn’t have to worry about capital gains taxes. Today, the median sales price nationally is over $400,000 and there are hundreds of cities where the typical home is worth $1 million or more, according to real estate site Zillow. That means more sellers are facing capital gains that could be reduced if they have the paperwork to prove they made qualifying improvements.
You can’t include the cost of maintenance or repairs, such as painting, patching or replacing broken hardware. If the repair is part of a bigger project, though, it may qualify as a capital improvement. Replacing a broken window pane is considered a repair, for example, but replacing the whole window is a capital improvement.
You also can’t include in your cost basis any improvement that was subsequently removed or redone. If you’d replaced your roof previously, for example, you couldn’t include that earlier expense when calculating your basis.