April 17 is around the corner and we realize that many of our existing and future clients will be submitting their 2017 tax returns. This week we will review the impact of the new 2018 tax law on making improvements to your home.
The amount of tax that Americans pay is based on the amount of income that they earn from their employment, investments and other sources less permitted deductions and tax credits. Tax credits reduce tax liabilities. Common credits include the child tax credit, which doubled to $2,000 per child under 17 with the new tax law and can be taken by single parents who make up to $200,000 and married couples whose income is less than $400,000. A $2,000 tax credit will reduce your tax liability by $2,000 and save you $2,000 in taxes.
By comparison, a tax deduction lowers taxable income to an amount equal to your marginal tax bracket. If you are in the 32 percent federal income tax bracket and you are entitled to a $1,000 tax deduction, your tax bill would be reduced by $320 (0.32 x $1,000 = $320).
How you finance renovating an existing kitchen or bath will have different tax consequences in 2018 and beyond. The Internal Revenue Service recently posted on www.IRS.gov that homeowners can deduct interest on home equity lines of credit and equity mortgages provided the funds are used to purchase a home or to repair or improve the property. That means if you use a home equity line of credit or second mortgage to pay for your new kitchen or bath remodel, you can deduct the interest payments on those loans up to a certain limit. The new tax law caps interest on loans up to $750,000 for married couples and $375,000 for singles. If the combined home equity and initial mortgage loan exceed those limits, interest paid above those amounts is not deductible.
If you fund renovations from savings, you most likely will not receive immediate tax benefits, because using savings does not provide an immediate deduction. However, those funds are factored into the value of your home when it is sold. When a home is sold, the IRS requires sellers to pay taxes on the difference in the original price owners paid for the home and the sale price of the home. The amount of tax you pay depends on how long you have owned the home and if you are single or married and file a joint return.
If you owned the home for five years and lived in it as your principal residence for two of the five years, you can exclude $250,000 of the profit from capital gains taxes if you are single and $500,000 in profit from taxes if you are married filing a joint return. However, improvements you have made to your home that increase the home’s value substantially while you have owned it can reduce your tax exposure even more.
If you purchased your home in 1980 for $200,000, spent $50,000 renovating your kitchen in 2018 and $30,000 renovating your master bath in 2019, then the basis of your original purchase price for tax purposes would be $280,000. IRS will only allow you to increase the cost basis of your home if the improvement adds substantial value such as new kitchens and bathrooms, additional rooms, new roofs, etc. Check with your tax professional to determine which improvements would help raise the base of your home.
Additional tax benefits of owning a home and making improvements to it include the right to deduct the amount of interest you pay on both original mortgages and home improvement loans (or equity lines of credit). Real estate taxes also may be deductible up to a limit of $10,000.
When you are considering a new kitchen or bath, do not overlook the potential tax benefits associated with making substantial improvements to your home or the ability to deduct interest on a home improvement loan. More important than a possible tax benefit is a new kitchen and bath make your life easier, more enjoyable and rewarding. That’s priceless.
We would welcome the opportunity to meet with you and discuss your ideas for remodeling. Give us a call at 781-749-6777 or send an email to [email protected]. Please note, consult a qualified tax expert before taking any action on the guidance in this blog.