NEW YORK (CNN/Money) -
My husband and I just finished doing a lot of remodeling on our house. Are our renovation expenses tax deductible? We've been saving the receipts.
-- Christina Pettis, Lorton, Virginia
With one exception (which I'll get to below), the answer is no -- home improvement expenses aren't tax deductible. But to paraphrase what Mark Twain once said about Wagner's music, that's not as bad as it sounds.
The reason is that certain improvements can add to the cost basis of your home. Which means that, depending on what kind of improvement you've done and how large a profit you realize on the sale of your house, those expenses can may be able to lower your tax bill when you sell your home.
Let's take an example. Suppose that many years ago you paid $100,000 for your home. And let's further assume that because of the incredibly hot real estate market you and your husband were able to sell your home for $700,000 this year, giving you a profit of $600,000. Since $500,000 of home-sale gains are tax-free for married couples (the exclusion is $250,000 for singles), you would have to pay tax on a gain of $100,000.
Now, if somewhere along the way you had also spent $100,000 on an addition to your home to accommodate your growing family, your tax situation would change. In that case, you would add the $100,000 of home-improvement expenses to your original purchase price of $100,000, giving you an adjusted basis of $200,000.
To figure your profit, you would then deduct this adjusted basis from the sales price, in this case leaving you with a $500,000 gain. (I'm leaving out real estate commissions and other possible items for simplicity's sake.) Since that gain falls within the home-sale exclusion for married couples, you would owe no tax on the sale of the home. In short, by adding the addition to your original basis or purchase price, you lower the potential taxable gain on the sale.
Not all home improvements are created equal
Not all improvements increase your home's cost basis, however. To qualify, the IRS says an improvement must "add to the value of your home, prolong its useful life, or adapt it to new uses." Typically, projects like modernizing a kitchen, adding a room and building a deck are considered ones that add to the value and the basis of your home.
Repairs that simply maintain your home in good condition, however, don't qualify. Thus, money spent, say, to repaint your house or repair broken windows don't increase the basis. For a list of the types of improvements the IRS sees as increasing your home's basis as well as other ways you might increase the basis of your home, go to the IRS Web site and download "Publication 523: Selling Your Home."
Some exceptions apply
Now about that exception I mentioned earlier. If you make a home improvement for a bona fide medical purpose, then you can deduct the expenses, subject to certain conditions. If the improvement doesn't increase the value of your home, then the entire expense is deductible. If the improvement does increases the value of your home, then only the amount that exceeds the increase in your home's value is deductible.
Remember too that medical expenses are only deductible to the extent that they exceed 7.5 percent of your adjusted gross income for the year of payment. For more on these and other niggling rules concerning home improvements and medical expenses, go to the IRS Web site and download "Publication 502: Medical and Dental Expenses."
Finally, I'm glad to see that you're saving your receipts. It won't come as a surprise that the IRS requires that you keep records to prove what you spent on improvements that increase your home's adjusted basis. For details on what kind of documentation you should keep and how long you should hold onto it, check with good old "Publication 523."
Walter Updegrave is a senior editor at MONEY Magazine and is the author of "Investing for the Financially Challenged." He can be seen regularly Monday mornings at 7:40 am on CNNfn.