Although home improvements are often expensive, they can also create tax-saving opportunities. But just as renovations involve many details — measurements, materials, specifications and so forth — applicable tax breaks come with rules and limits all their own. Let's explore some possibilities.
If you itemize deductions on your return, you can generally write off mortgage interest paid on a principal residence and one other home, such as a vacation home, within specified limits. To qualify for the deduction, though, you must be legally obligated to pay the mortgage secured by a qualified residence.
How does all that relate to home renovations? Well, there are two primary kinds of mortgage interest debt:
Before the TCJA, you could deduct interest paid on up to the first $100,000 of home equity debt used for any purpose, including paying off credit cards or buying a car. However, the TCJA temporarily suspended this deduction, and the OBBBA permanently eliminated it. So, interest on home equity loans generally isn't deductible.
But there's an exception for proceeds used to buy, build or substantially improve the home that secures the loan. In that case, the portion of the loan used for substantial home improvements — such as building an addition, finishing a basement or attic, or installing an in-ground pool — will likely be treated as acquisition debt, making the related interest potentially deductible as mortgage interest expense within the applicable limits.
Every homeowner should learn about the home sale gain exclusion. If you sell a home that you've owned and used as your principal residence at least two out of the last five years, you may exclude from tax up to $250,000 of gain ($500,000 for joint filers). To qualify for the larger $500,000 joint-filer exclusion, at least one spouse must pass the ownership test, and both spouses must pass the use test. Your principal residence for the year is the place where you spend most of your time during that year.
In the past, the home sale gain exclusion frequently covered the full amount of gain, but high housing prices in many areas could result in a portion of your gain being subject to tax. Fortunately, you can adjust your basis for calculating the gain to reflect home improvements, thereby reducing (or even eliminating) any taxable gain.
For example, say Deborah and Ralph bought a home for $200,000 shortly after they were married, but sell the property for $800,000 sometime this year. Normally, this would generate a gain of $600,000 ($800,000 minus $200,000 of tax basis). And the excess $100,000 above the exclusion amount would be taxable ($600,000 minus $500,000).
However, Deborah and Ralph made $150,000 in home improvements over the years. The tax code allows them to adjust their tax basis for the home improvements, so their adjusted tax basis is $350,000 ($200,000 plus $150,000). As a result, their gain on the sale is only $450,000 ($800,000 minus $350,000). This is less than the home sale gain exclusion of $500,000 for joint filers, which means the entire gain is tax-free.
Important: Keeping good records is essential. You must be able to back up your home improvement amounts with receipts, contracts or other documentation in case the IRS challenges them.
Taxpayers who itemize can deduct qualified unreimbursed medical expenses above 7.5% of adjusted gross income (AGI) for the year. So, for instance, if your AGI is $100,000, your annual deduction equals any amount greater than $7,500 (7.5% of $100,000). If you spend $8,000 in qualified expenses, your annual deduction is limited to $500 ($8,000 minus $7,500).
For this purpose, a qualified expense must be incurred primarily for the prevention or alleviation of a physical or mental defect or illness. On the other hand, an expense that's merely beneficial to your general health isn't deductible.
What's great is that if you make a home improvement that's medically necessary, you can deduct the amount above the resulting increase in the home's value. For example, suppose you install an in-ground pool based on a physician's advice to accommodate swimming by a spouse with a heart condition. The pool costs $25,000 and increases your home's value by $15,000, so you can add $10,000 to your qualified medical expenses.
This can increase an existing medical expense deduction (if you're already above the AGI threshold), or it may be enough to put you over the AGI threshold for the year. When possible, try to bunch medical expenses in a tax year in which you expect to clear the annual AGI threshold.
The OBBBA generally limited tax credits for energy-efficient home improvements to qualifying property placed in service (installed, not merely purchased) through December 31, 2025. So, these breaks aren't available for improvements made in 2026 or later.
However, you may want to inquire with your tax advisor about filing an amended 2025 tax return if you overlooked a credit, claimed too small a credit or failed to include the required information. The IRS generally requires amended returns claiming refunds to be filed within three years after the original return was filed or two years after the tax was paid, whichever is later. The two major credits to ask about are:
Home renovations are often driven by a vision — to beautify a space, to make it more efficient and functional, to allow someone to stay at home longer, or some combination thereof. Taxes probably aren't the first thing on your mind.
But don't ignore them. With the right strategies and documentation, you may be able to preserve valuable deductions, reduce future taxable gain or even recover overlooked savings on a previously filed return. Put your tax advisor on your project team.
Get in touch today and find out how we can help you meet your objectives.
