Home improvements are always an investment. But whether you’re putting money into your own home for your convenience and comfort, or remodeling a vacation property or home office, it’s nice to claim a tax deduction or two for the work. Periodic upgrades to your home are necessary to maintain or increase value, plus they make your life easier. Here are six deductions or credits you should consider, depending on the property and the remodeling plan you have in mind.
At the federal level, the biggest tax deductions you can expect for renovations of your primary residence involve upgrades for energy efficiency. For improvements made in 2020 and 2021, the federal government offers Non-Business Energy Property Tax Credits and Renewable Energy Tax Credits. The first provides a tax credit of 10 percent, up to $500, on efficient upgrades like heat pumps or furnaces, as well as structural improvements like roofing or windows.
If you’re looking to make a larger upgrade to your home’s energy systems, the Renewable Energy Tax Credit may help lower the total cost you pay. This credit applies to systems put in service from 2020, with a step down in value through 2021. Installation in 2021 could get you a 26 percent credit on:
The best part of this one is that it applies to most residences. If the upgrade’s going on a vacation or second home that you don’t use as a rental, you may be able to take advantage of this credit.
Although people usually think about federal tax programs, it’s important to keep state and municipal-level rebates and credits in mind. Arizona offers a great, one-time credit for solar energy devices, up to 25 percent or $1,000. There’s a lot of flexibility in this credit. If you’ve already installed solar panels but you’re looking to expand it, for something like water heating or lighting, the credit may apply to your project. And as always, look for tax rebates offered by your utility company. Programs on small purchases like a smart thermostat or sprinkler control might not seem like a lot, but they add up.
Most remodeling projects for your home don’t apply for tax deductions, but it depends on what you use it for and how you pay for it. For example, with interest rates staying low, it might make sense to take advantage of a cash-out refinance or home equity line of credit to pay for home improvements. If you’re itemizing deductions, which is common if you have a sizeable mortgage, you may also be able to deduct the interest you pay for a HELOC. Keep in mind that the limit on mortgage interest is up to $750,000 (in total mortgage value, not interest paid). But if your mortgages are relatively low, you might be able to claim interest for a primary and secondary home under these rules.
If you’re like millions of Americans, working from home and running your own business is becoming a bigger part of your life every year. Although the IRS is pretty specific about how you can claim home office deductions, improvements to your home office space may also count as a deduction. You already claim business expenses like technological equipment and supplies. If you make some structural improvements to your home office–say, installing a new bathroom or kitchen for you and your employees–you may be able to deduct or depreciate at least a portion of the cost. Remember that if you use the space for non-business purposes too, you’ll typically need to calculate a percentage of the expenses for deduction or depreciation.
If the renovations concern a second home, what you do with it when it’s unoccupied might affect your tax liability. For example, if you live in your second home only a week or two out of the year but rent it out the rest of the time, you might be able to claim improvements as part of your rental business. This also applies to portions of your primary residence that you rent out. Just keep in mind that how you classify a property may change multiple deductions. You usually can’t claim mortgage interest for a residence at the same time as deducting improvements for the same property as a rental.
Even if none of the other options apply to your remodeling project, there may be significant tax advantages for you in the future. The IRS offers an exemption of up to $250,000 ($500,000 for married filing jointly) on capital gains taxes for your primary residence. You must meet certain requirements, but it’s also possible to claim the exemption for vacation or investment properties that used to be your primary residence. This might seem like a huge exemption, plenty to cover almost anyone. But if you own your home for decades or it sustains a significant increase in value before you sell it, you might end up with a significant rise in your tax liability that year. It all depends on the tax basis.
In very simple terms, capital gains refer to the change in value since you purchased the asset. Investments into the property can change that basis. For example, if you bought your house at $250,000 and it’s now worth $1 million, that could be $750,000 in capital gains. Even if you can exempt the full $500,000, that’s still an extra $250,000 in income to claim on your federal taxes. However, an investment of $200,000 or more in improvements over the years could raise the tax basis, cutting down on the capital gains tax liability you might have to manage. If you’re thinking about selling sometime in the next few years, this might be an excellent time to maximize your enjoyment of the improvements while significantly reducing your tax liability later.
Although big tax deductions usually aren’t the biggest reason to remodel your home, these options can help minimize the cost. Home improvements are always a joy when you start with qualified, experienced professionals like Hochuli Design & Remodeling Team. If you’re ready to start a project that improves your life, solves problems and shows off your own personal style, contact us today.