HOME RECORDKEEPING: MAINTAIN YOUR COST BASIS TO REDUCE TAX

To minimize taxes on the eventual sale of your home, keep good records of expenditures on your home. The tax you eventually have to pay when you sell your home will be calculated from your cost basis (“basis”). It’s your job to keep track of your basis, and maintain documents that support your basis calculations. A higher basis means lower taxes, so you want to build up your basis, but in doing so you must conform to rules set by the IRS. The rules are not too complex.

To start, your cost basis begins with what you paid for the home. Add to that the costs you incurred in purchasing the home, including costs associated with financing your home. The accompanying table lists home purchase costs that may be added to the basis, and those that may not.

Next, because you own your home and make improvements to it, you’ll want to add some of those costs to the basis. In particular, you’ll add the costs that can be deemed capital improvements (“improvements”). An improvement “materially adds to the value of your home, considerably prolongs the useful life, or adapts it to new uses.” Examples are adding a room, finishing out a basement, installing a fence, putting in new plumbing or wiring, paving a driveway, replacing a heating or air-conditioning unit, or putting on a new roof.

Repairs are not considered improvements. Repairs keep your home in ordinary, efficient operating condition. Repairs also can be considered maintenance, as are keeping your house clean, in good working order, and acceptable in appearance, including painting, appliance repairs and yard work. These costs cannot be added to the basis of your home.

Today, so long as you live in your home for more than two years, you will enjoy a $250,000 tax deduction on any gain you receive on the sale of your new home if you are single, and a $500,000 deduction if you are married and file jointly. So, for example, if you are married and bought your home for $300,000, added $100,000 to your basis while you owned it (by improvements, so that the basis at the time of sale was $400,000), and then sold it for $700,000 (for a gain of $300,000), you would owe no tax because the entire $300,000 gain would be sheltered by the $500,000 deduction allowed by current IRS rules. In other words, your basis-substantiating recordkeeping would go unrewarded. That’s because your $500,000 home sale deduction would completely shelter even the $400,000 gain that you received from the original purchase price of your home. You did not even need to use any of your $100,000 in basis-increasing improvements to shelter you from having to pay capital gains tax.

So if you don’t think that you will be so fortunate as to be able to eventually sell your home for a gain that exceeds $500,000 of the original purchase price (or, if you are single, $250,000), you are free to choose not to maintain your increasing basis and the records that support them. But if you take this route, you run the risk that either the tax law will change or your home will appreciate more rapidly than you currently anticipate. Neither is unlikely. So our recommendation is that you maintain your basis and records to support it. It’s not very difficult and could save you big dollars.