Tax Matters

Tax Matters

By David Katzman

If you just purchased a home, you’re probably not thinking about your potential gain when you eventually sell—but you should be. From your first day of purchase, you should carefully track your expenses so you can document an accurate “basis” for your home.

For federal income tax purposes, your basis is the purchase price of your home, including qualifying settlement and closing costs. If you had your home built, your basis is generally determined by the total cost of building, but there are some specific guidelines regarding labor, particularly if you acted as your own builder.

While this initial purchase price establishes the bulk of your basis, home improvements and other qualifying expenses can be added in subsequent years. To take advantage of these increases, you’ll need to keep careful records. Establishing the highest possible basis could save you tax dollars when you sell. A higher basis might also allow you to take a higher annual deduction if you have a qualifying home office or use a portion of your home as a rental.

To determine gain from the sale of your home, you subtract your basis from the selling price. If you purchased your home for $100,000 and sold it 20 years later for $500,000, your gain would be $400,000, if your basis remained static. Generally, the federal government allows you to exclude up to $250,000 in gains on a qualifying sale of your principal residence for single taxpayers, and up to $500,000 for married taxpayers. Any gain above this exclusion amount is subject to tax. In this example, a married couple would be entitled to exclude the entire gain. However, a single taxpayer would owe long term capital gains tax (currently 15%) on $150,000, the amount in excess of the exclusion, unless the home’s basis had increased during the 20 years.

How do you increase your basis?

While many costs of homeownership, such as upkeep and repairs, are not deductible, some expenses can be added to your purchase price to increase your basis. Generally, qualifying expenses must contribute to the long-term value of your home, not just ongoing maintenance of your property. Here are some examples of qualifying expenses:  

• a room addition
• the cost of built-in appliances
• an outdoor addition, such as a deck or garage
• finishing a basement
• adding a fence, improving landscaping, installing a sprinkler system, paving your driveway
• adding central air conditioning or changing your heating system
• adding a security system, a central vacuum unit or even getting satellite television
• special assessments for local improvements
• money spent to restore property as a result of a casualty loss

In some instances, your basis could decrease during the years you occupy your home, which you will also need to track. If, under the regulations in effect before May 7, 1997, you deferred a gain on a previously sold home, this deferral will reduce the basis for your next home. Other examples of payments that could decrease your basis include depreciation for the use of a portion of your home for business or rental, energy conservation subsidies, deductions taken for casualty losses.