Seller’s Home Improvements Pose a Puzzle at Tax Time
Tax season is fast approaching and it’s once again time to put our financial houses in order.
For homeowners who sold their primary residence during 1992, the task of ferreting through receipts and ledger books is even more complicated. For these lucky taxpayers get to add IRS form 2119 to the list of other forms they’re already filing. The Sale of Your Home tax form requires home sellers to figure the cost basis of their old home and the so-called adjusted basis for any new home purchase.
It’s all part of the way our federal government lets us figure the real cost of a home and defer any capital gains--i.e., profit.
Homeowners can defer capital gains indefinitely by rolling over their profit on one home into another home of equal or greater value. Homeowners age 55 who sell their home and don’t move up also have a onetime opportunity to realize up to $125,000 in tax-free gain on the sale of their primary residence.
Unfortunately for many in the San Fernando Valley and Ventura County who have lost money on the sale of their homes, one frustrating aspect of the tax code is that homeowners who sold at a loss last year get no tax break for that loss. So you must absorb the loss yourself.
The question of whether you made a profit or loss on the sale of a residence depends on the real cost--or cost basis--for a home. It means the purchase price, plus any permanent improvements added during the time you’ve owned that home. Keeping all the receipts is the easy part. Figuring out whether something’s a “permanent improvement,” as opposed to a mere replacement for something, however, is a complicated tax challenge.
“The general rule is that maintenance or replacement can’t be included in the calculation of cost basis,” said John Murphy, tax partner, Deloitte & Touche in Woodland Hills. “The key issue is whether you are making a permanent improvement.” This means that replacing your carpets probably won’t help you increase the cost basis of your home and lower the taxable gain. But, Murphy said, owners who upgrade from a cheap shag to a pricey wool Berber carpet can probably use the price differential between merely replacing the old carpet versus installing the improved floor covering. It’s worth noting that some other CPAs say that any new carpet counts as a permanent improvement.
The debates can be endless. In the end, however, if you are audited, “you are under the discretion of the IRS agent,” said Philip J. Holthouse, a resident of Sherman Oaks and partner in the West Los Angeles accounting firm Holthouse, Carlin & Van Trigt.
Matters become further complicated when a homeowner does a series of renovations over several years. An owner might reface kitchen cabinets one year and then replace the cabinets altogether a few years later. Can the refacing job still count as part of cost basis? Holthouse said it depends, but generally you should ask whether the old improvements are being trashed or whether they’re being added to.
“The biggest thing is to keep the receipts,” Holthouse said. While there’s a three-year statute of limitations for a federal audit and a four-year statute of limitations for your state return, if you roll all the profit on your home into the purchase of another, “the history in all your previous homes is still very relevant,” he said. That means you could be called in for questioning by the IRS about things that happened decades ago. What makes matters worse, Holthouse said, is that “most people don’t keep really accurate records.”
So keep all records on primary residences even after you have moved.
Accountants and the IRS generally do agree on the following: The cost of buying a home does figure into your cost basis. This includes attorney’s fees, title search and insurance, late closing charges, the cost of cleaning up title, broker’s commissions, property surveys, appraisal fees and the cost of recording the purchase.
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Improvements include installing storm windows and doors, adding a room, finishing a basement or attic, new plumbing or a furnace, a swimming pool or landscaping expenditures. Some of the things generally not considered permanent improvements are repainting a house, mending leaks or fixing gutters.
While a simple paint job won’t boost the cost basis of your home, aluminum siding will, said Aaron Zimmer, a CPA and attorney with the Encino law firm Grayson, Givner, Booke, Silver & Wolfe. A new roof may or may not count, depending upon whether it’s an “improved” roof; an improved roof might be fancy Mexican tiles versus composite shingles.
When you make certain improvements can also make a big difference. “Some things may count as improvements when first moving into a home that wouldn’t count later on,” Zimmer said. Those would fall under move-in costs, such as paint jobs and maybe replacing dirty carpets. Also, when selling a home, repairs made within 90 days of opening escrow do count as part of the cost basis.
Also, while the recession has made it tougher to sell a home, the opportunity of including repairs before the sale of a home is limited to 90 days before the sale opens. If a home languishes on the market, the seller gets insult added to injury.
Zimmer advises clients to keep their receipts in a safety deposit box or fireproof safe. Before and after photos or videotapes can also help if you’re ever called in for an audit. “Many people keep good records of the improvements to their home. Others never keep anything,” he said.
“There’s no bright-line test to define when you have a repair and when you have a qualified improvement,” said Brian Gourlay, tax manager at the Woodland Hills-based accounting firm Solomon Ross & Co. Homeowners shouldn’t worry too much, however. “You have to be able to substantiate your claims,” Gourlay said, “but 99% of the time, the IRS accepts the homeowner’s receipts.”
More information about the cost basis of your home is available by ordering a free 14-page IRS publication titled Tax Information on Selling Your Home.
This booklet and IRS form 2119 are available by calling the IRS at (800) TAX-FORM.
