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Sale price Minus adjusted cost basis
Your adjusted cost basis includes:
Original purchase price
Certain closing costs
Capital improvements
The higher your cost basis, the lower your taxable gain.
Example: You purchased your home for $350,000 and later made $60,000 in qualifying improvements. Your adjusted basis becomes $410,000. If you sell for $600,000, your taxable gain is $190,000 instead of $250,000.
That $60,000 in improvements reduces your taxable gain.
What Is a Capital Improvement?
A capital improvement is a permanent upgrade that:
Adds value
Extends useful life
Adapts the property to new uses
Routine repairs do not qualify.
Home Improvements That Typically Qualify
Major Structural Improvements
Room additions
Finished basement
Garage addition
Deck or patio installation
New roof
New siding
Systems Upgrades
New HVAC system
Plumbing replacement
Electrical rewiring
Septic system replacement
Interior Remodels
Kitchen remodel
Bathroom renovation
Built-in appliances
Flooring replacement (permanent)
Energy Improvements
Solar panel installation
Permanent insulation upgrades
Energy-efficient windows and doors
Land Improvements
Permanent landscaping
Retaining walls
Irrigation systems
Example: Installing a new $25,000 roof increases your cost basis by $25,000 and reduces taxable gain when you sell.
What Does Not Qualify?
The following generally do not increase cost basis:
Interior painting
Minor plumbing repairs
Fixing leaks
Replacing broken hardware
Cleaning carpets
Basic maintenance
These are considered repairs, not capital improvements.
The Home Sale Exclusion
Many homeowners qualify for the primary residence exclusion.
If you owned and lived in the home for at least two of the past five years, you may exclude:
Up to $250,000 of gain if single
Up to $500,000 if married filing jointly
However, if your gain exceeds those limits, capital improvements become especially important.
Example: A married couple sells their home with a $580,000 gain. The first $500,000 may be excluded, but the remaining $80,000 may be taxable. Improvements that increase the basis can reduce the taxable amount.
Why Recordkeeping Matters
To increase your cost basis, you must have documentation.
Keep:
Receipts
Contractor invoices
Building permits
Proof of payment
Store these records for as long as you own the home, plus at least three years after selling.
Without documentation, the IRS may disallow the adjustment.
Special Situations
Rental Property
Improvements to rental property are typically depreciated over time rather than added directly to the basis.
Medical Modifications
Some medical-related home improvements may also qualify as deductible medical expenses in the year installed, depending on circumstances.
Energy Credits
Some improvements may qualify for federal energy credits in addition to increasing cost basis.
When you sell your home, the capital gains tax is based on your profit.
