1: ABILITY TO DEDUCT YOUR MORTGAGE INTEREST:
If you take out a mortgage for home improvement purposes, the IRS may ask you to prove the project was a “substantial improvement” that:
- Adds to the value of the home,
- Prolongs the home’s useful life, or
- Adapts the home to new uses. For example, painting a room may not qualify, but an addition or new kitchen may qualify.
Keeping the receipts from your home improvement project would go a long way toward proving this. Also, keep in mind that the IRS gives you 24 months to reimburse yourself for improvements made in the past, or 12 months to complete future improvements. For more details, please reference IRS Publication 936, and see my article called, Three Things You Should Know About Pulling Cash Out for Home Improvement.
2: ABILITY TO REDUCE YOUR CAPITAL GAINS TAX:
Capital Gain is calculated by taking your sales price, minus your costs of selling the house, minus your “tax basis” (see illustration). Tax basis is the total cost of buying, building or improving your house. When you make a “substantial improvement”, the cost of the home improvement is added to your tax basis. This reduces your capital gain when you sell the house, and it could save you quite a bit of money on capital gains taxes. That’s another reason why it’s important to keep your home improvement receipts.
Please see a CPA for further details on the deductibility of mortgage interest or the capital gains tax in your specific scenario. Contact me for further information on your mortgage options.