How2Day: Tax Deductions for Renovations

Especially in rental property, tax deductions help finance renovations. Jupiterimages/Polka Dot/Getty Images
Every year "Remodeling" magazine performs a survey on the resale values of various remodeling projects. Its 2009 to 2010 study showed an 80 percent return on a wood deck addition. If you built the deck on a rental property, the tax deduction associated with the addition would make up the balance of your costs (that is, account for the remaining 20 percent) in just five years. The value of tax deductions for renovations combines with the resale value to form a solid one-two punch. (Reference 1)

Depreciation is a tax deduction that allows you to recover business costs. On rental property, all capital improvements can be depreciated. By IRS definition, a capital improvement is an improvement that adds value to the asset (which, in this case, is a rental building) and that has a useful life of over one year. Major renovations and some minor renovations are capital improvements. The IRS defines the term of the useful life and allows several methods of depreciation calculation. The most commonly used method is called straight-line depreciation, in which the cost of the renovation is divided by the useful life term. For instance, a major kitchen remodel in a residential rental building has a useful life of 27.5 years. If the cost was $50,000, the annual depreciation allowed is $1,818 ($50,000 divided by 27.5 years). You can deduct $1,818 each year for 27.5 years as an expense.

Small renovations often fall into the category of repair and maintenance rather than capital improvements. The cost of these renovations, when made to rental property, can be fully deducted as a business expense in the year the renovations are made. Examples of expenses include both interior and exterior painting and replacement of fixtures.

When you sell your home, you are allowed a $250,000 exemption from taxes if you are single, or a $500,000 exemption from taxes if you are married on the profit. You are also allowed to subtract the cost of the capital improvements you made to your home over the years from the profit calculations. To use the exemption, you had to have lived in your home two of the last five years prior to the sale. If you sell without having met these conditions, you must pay long-term capital gains tax on the entire profit, assuming you owned the house more than a year. The cost of capital improvements, however, can also be subtracted from the profit figure in this case.

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