It’s time to finish doing all of the things we wanted to complete in 2011, because there’s just one week left. You know, the last-minute contributions to charities, selling stocks in order to capture capital gains or losses, and so on. We also should be thinking about real estate.
Why think about real estate? Well, if you’re thinking about selling your home in 2012, it’s a good time to make a list of all of the things you want to do before you put your house on the market, and to start working on the list, item by item. It might be simple things, like de-cluttering and cleaning, or more extensive things like painting and making repairs. After all, your goal is to have your house appeal to as many people as possible when you put it on the market. This usually means having a spotless home in “move-in” condition that will appeal to a wide segment of the market.
Even if you’re not planning to move next year, it’s a good idea to start making a list of all the home-related things you want to do, whether that involves doing things yourself or hiring someone to do them. Many people like to take advantage of winter weekends to do a bit of do-it-yourself painting or wall papering. If the weather’s going to be cold and blustery and you’re going to be indoors anyway, why not work on those projects that you certainly won’t want to tackle once you can enjoy the sunny warm weather again.
Even if you have absolutely no plans to move in the foreseeable future, take the time to add all of the permanent improvements you made in 2011 to your list of home investments. You know, the list that you’ve been keeping since you bought your home? The list of all of the dollars you’ve spent on major projects to improve your home? It should be a list with the date of the improvement, a brief description of what you did (replace the furnace, put on a new roof, renovate the kitchen, etc.), and the amount that you spent on each project. Wherever possible, you should also have a receipt, a cancelled check, or a credit card bill supporting each improvement.
The list is important because you may have to pay a capital gains tax when you eventually sell your house. Capital gains for a house are similar to capital gains on a stock, i.e., the net selling price minus the total buying price equals the capital gain (or loss). There’s one important difference when we’re talking about homes, however. The Taxpayer Relief Act of 1997 gives the owner of his/her principal residence a $250,000 exemption on any capital gains achieved when the home is sold ($500,000 for a married couple). If your capital gain is less than the $250,000/$500,000 exclusion, you don’t have to pay a tax on the capital gains. However, if your home has increased in value more than those $250,000/$500,000 exclusions, then you will have to pay taxes on the amount which exceeds those numbers. If you’ve been living in the same home in our area for 10, 20 or more years, it’s easily possible to exceed those limits.
Here’s where your list of home improvements comes in. You’re entitled to add the cost of all of your permanent home improvements to the purchase cost of your house when you set the base for your total purchase price. Here’s an example. Let’s say you bought your house for $200,000 and now you expect to sell it for $850,000. At first glance, the increase in the value of your home is:
$850,000 selling price
-$200,000 buying price
$650,000 capital gains
For a married couple, you’re allowed a $500,000 exemption on the capital gains realized when you sell your house, but in the example above you still have $150,000 of taxable capital gains.
Now, suppose during the years you owned the house you spent $8,000 on a new furnace, $6,000 to add a central air conditioning system, $30,000 to renovate the kitchen, $30,000 to replace all of your windows with thermal pane windows, $20,000 to renovate 2 bathrooms, $10,000 on additional insulation, and $7,000 for a new roof, for a total of $101,000 in permanent improvements. Now when you calculate your capital gain, you have:
$850,000 selling price
-$200,000 buying price
-$101,000 permanent improvements
$549,000 capital gains
With your $500,000 married couple exemption, you’re now only subject to a tax on $49,000 of your capital gains. If you sit down and think about it some more, you may be able to find other, smaller capital improvements that you made over the years. Had to replace your hot water heater twice? What did that cost? Did you upgrade your electrical panel from a 100 amp to a 200 amp panel? What did that cost? Put in a radon mitigation system? You get the picture.
If you update your permanent improvement list at the end of every year, you’re much more likely to have the numbers (and receipts) at your fingertips. So what are you waiting for? What did you spend on improving your home in 2011?