- Home gain exclusion amounts
- Home cost
- Reasons to keep home improvement records
- Records may be required to avoid tax
- Which records to keep and for how long
When the sales price, net of selling expenses, is more than the cost of an individual’s primary home the resulting gain would be taxable if not for a provision in the tax law that allows some or all of the gain to be excluded from the seller’s income. Of course, certain requirements must be met to use the exclusion. For example, homeowners must meet 2-out-of-5-years use and ownership tests to be able to exclude up to $250,000 ($500,000 if both filer and spouse qualify) of home sale gain. You also can’t use the exclusion more than once in a two-year period. Some exceptions to the rules apply in cases where there are unforeseen circumstances, such as a change of job location or illness.
To know if there’s a gain, you need to know what the “cost” of the home is. In addition to the original purchase price of the home, expenses of making improvements to the home during the ownership period count toward cost. If a homeowner expects the gain from selling the home won’t exceed the exclusion amount, then they may not bother to keep a record of the cost of the home improvements. However, in many instances the gain from the home’s sale can be substantially higher than the allowable exclusion amount; having a record of improvements can be very beneficial and lead to tax savings.
Here are some situations when having home improvement records could save taxes:
- The home is owned for a long period of time, with a significant appreciation in value due to inflation, and the gain exceeds the exclusion amount. Adding improvement expenses to the cost could bring down the gain so that it would be covered by the exclusion.
- The home is converted to a rental property, and the cost and improvements of the home are needed to establish the depreciable basis of the property.
- The home is converted to a second residence, and the exclusion might not apply to the sale.
- You suffer a casualty loss and retain the home after making repairs.
- The home is sold before meeting the 2-year use and ownership requirements.
- The home only qualifies for a reduced exclusion because of an unforeseen circumstance and the home is sold before meeting the 2-year use and ownership requirements.
- One spouse retains the home after a divorce and is only entitled to a $250,000 exclusion instead of the $500,000 exclusion available to married couples.
- There are future tax law changes that could affect the exclusion amounts.
Everyone hates to keep records but consider the consequences if you sell your home at a gain and a portion of it cannot be excluded. You will be hit with capital gains (CG), and there is a good chance the CG tax rate will be higher than normal simply because the gain pushed you into a higher CG tax bracket. Before deciding not to keep records, carefully consider the potential of having a gain in excess of the exclusion amount.
As to what records to keep, we aren’t saying you need to keep the receipt for every time you buy a can of paint or replace a ripped screen (these wouldn’t be eligible as improvements anyway). But you should maintain receipts, invoices, contracts, etc., and cancelled checks, credit card receipts or bank records to prove payments when you make improvements such as adding a room, putting on a new roof, and remodeling the bathroom. Retain these records for at least 3 years (some recommend 6 years) after the later of the due date of the tax return on which the home sale is reported or the date the return was actually filed. The retention period may be longer depending on your state’s rules.
If you have questions related to the home sale gain exclusion or questions about how keeping home improvement records might directly affect you, please give this office a call.