Tax-deductible Home Improvements
It may have been your dream house when you bought it, but most homeowners soon come up with a long list of ways to improve it. While ideas are never in short supply, the money to carry out those home improvements is often lacking.
The good news is the Internal Revenue Service often offers assistance to homeowners remodeling, renovating and otherwise improving their homes. A collection of tax incentives for homeowners to make energy-efficient improvements took effect in 2006. "Depending on how you slice and dice it, there are two or three credits in this area," says Mark Luscombe, principal tax analyst at CCH, a tax publisher and software provider.
The tax-favored home improvements range from replacing windows and doors, to adding insulation or special roofing material, to converting heating and cooling systems to solar power.
The best thing about these tax breaks is that they are credits, which reduce IRS bills dollar for dollar. And while some credits are phased out once a taxpayer earns a certain amount, these credits are available to any homeowner, regardless of income.
The home energy credits, however, do have some limits. There are different credit levels for various home projects, and those that are most common and easiest to install provide the smallest credits.
Energy Improvements
Overall, the Energy Tax Incentives Act of 2005 established a 10 percent tax credit with a lifetime cap of $500 for conventional technology home improvements. The credit is based on the cost of new energy-efficient improvements including insulation, exterior windows, exterior doors, water heaters, heat pumps, central air conditioners, furnaces and hot water boilers.
Within each conventional energy-saving category, the specific credit amounts also are limited. And the $500 cap applies to total energy upgrades made in both 2006 and 2007, not separately for each year. So if you claimed the maximum $500 worth of eligible energy improvements in 2006, you get none in 2007.
This portion of the credits expires Dec. 31. Tax breaks for solar-related upgrades, however, are allowed on an annual, not cumulative, basis and these credits will continue through 2008.
Solar Tax Savings
Homeowners who opt for the more expensive solar renovations can claim up to $2,000 in credits each year. Qualifying home improvements that count toward that annual amount include solar water-heating systems, solar equipment that generates photovoltaic electricity for the home and fuel-cell power systems.
The IRS has issued official guidance on the residential tax credits, and official EnergyStar.gov has transferred those details to a helpful chart.
"Buy the right things," says Donna LeValley, attorney and contributing editor of "J.K. Lasser's Your Income Tax 2007." "Take the chart to the hardware store to help you find what can give you a tax break."
Also look for credit details on the packaging. Most manufacturers provide energy ratings and many have added labels alerting buyers that the item qualifies for one of the new tax credits.
Don't forget to check on your state's energy tax breaks via the Database of State Incentives for Renewables & Efficiency. Many also offer tax incentives which might be more generous than the federal credits, says Anne-Maire Fisher with CBIZ Accounting, Tax & Advisory Services in Chicago.
Medical Renovations
Some residential modifications also can provide deductions that could reduce a tax bill. Most of these, however, are in the medical area, which could mean costly upfront expenses.
You can include as medical expenses amounts you pay for special equipment installed in a home or for home improvements when the main purpose is medical care for you or your spouse. You can then deduct these amounts as long as you follow your doctor's orders and the IRS's rules.
LeValley says the IRS has a "bright line" standard: "Anything that increases the value of the home is going to offset the deduction."
However, says Luscombe, "The IRS on the whole has been getting more generous with medical deductions. And with respect to the home, something that is helpful to a disabled person but doesn't increase the long-term value of the home is likely to be able to help reduce your tax bill."
If you need, for example, to add a chair lift to get up and down the stairs, the IRS generally considers that a legitimate expense. Other deductible projects that make a house more accessible for a handicapped resident or individual with chronic medical problems are:
• Adding ramps
• Widening doors and hallways
• Lowering counters and cabinets
• Adjusting electrical outlets and fixtures
• Installing railings, support bars and other bathroom modifications
• Changing hardware on doors
• Grading exterior landscape to ease access to the house
In addition to deducting the actual remodeling costs, you also can deduct the ongoing expenses to maintain or operate any medically prescribed equipment.
Partial Medical Deductions
If you do make changes to your home that add to the property's value, you might still get some tax savings. "You really have to look at how much it increases the value," says Fisher. "If the improvement is more than the increase, you can deduct the excess."
Fisher offers a simple example: A person suffering from cystic fibrosis is told by physicians to maintain a constant temperature and high humidity in the home. The homeowner installs a central air conditioning unit costing $1,300, but it only increased the value of the home by $800. In this case, the $500 excess is deductible as a medical expense.
Such valuation issues also could help in convincing the IRS that the cost, or at least a part of it, for a swimming pool is deductible.
"That's the most common home improvement tax deduction question," says Fisher. "And there are times when a pool could be deductible. If it's prescribed as physical therapy, an ongoing treatment and not just for a few weeks. You also need to prove it was for medical purposes and are using it as prescribed. Special equipment bolsters the argument, for example, a bar to hold onto or special chairs, special jets beyond a typical pool."
Documentation Demands
In such cases, the extent that the pool cost exceeds the improvement value is deductible. But in order to successfully claim the deduction, you'll need documentation.
The best audit ammunition is a doctor's letter or statement detailing why a home improvement is recommended therapy for treatment of a chronic condition. "If there are alternatives, the IRS might say no, so be ready to show that the alternatives were too burdensome or didn't address your condition,'' says LeValley. In the case of a pool, for example, showing that not every nearby gym has a pool or not every pool is open year round could help convince the IRS of the medical claim's validity.
"You're getting into situations that are very fact-specific and you should pretty clearly have it documented that any improvement is a medical necessity," agrees Luscombe.
Filing Details
Finally, when claiming medical deductions, both the medically necessary home improvements as well as the more run-of-the-mill health care costs must be itemized on Schedule A. And only the amount that exceeds 7.5 percent of your adjusted gross income is deductible.
If you have to make major residential renovations, that threshold might not be a problem. But if it looks like you might fall just short of the required amount, coordinated health care and tax planning could help.
Consider bunching your expenses, including home improvements, when possible. "You probably don't want to wait on serious medical conditions," says Luscombe, "but if it's possible to push improvements into one tax year so that you get over the 7.5 percent, do that."
And don't forget about the alternative minimum tax (AMT). If you end up facing this parallel tax, the threshold to deduct medical expenses goes from 7.5 percent to 10 percent. Talk with your tax adviser or use the IRS's AMT online calculator to see if the tax might pose problems with any medically-based home improvements you plan to make.
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