When you are improving your home, you can take several deductions or possibly a tax credit to reduce your tax liability. These deductions can be either above-the-line deductions or itemized deductions. You must chose whether to take the total of your itemized deductions or the standard deduction on your tax return. You can take above-the-line deductions regardless of whether you take the standard deduction.
If you take out a mortgage or home-equity line that is used exclusively for home improvements, you can deduct the interest on first $500,000 of the loan. If you are married and file a joint return, you can deduct the interest on the first $1,000,000 of the loan. This is an itemized deduction on Internal Revenue Service Schedule A.
If you refinance your loan, you are allowed to deduct the points that you pay. However, instead of being allowed to deduct them at the time the loan is issued like a mortgage, you have to deduct them over the life of the loan. For example, if you paid $3,000 in points on a 15-year home-equity loan, instead of deducting the $3,000 in the year you take out the loan you would deduct $200 each year. If you end the loan early, you can deduct the remaining value of the points. For example, if you paid off the loan at the end of the fifth year, you could deduct the remaining $3,000 at that time. Points are an itemized deduction.
Energy Efficiency Tax Credits
If your home improvements include certain types of energy-efficient improvements, you may be able to clam a tax credit. These improvements include solar water heating and electric power, geothermal heat pumps and small wind turbines. Your credit is equal to 30 percent of the cost of installing the products up to $500. This is a credit rather than a deduction, which means that instead of reducing your taxable income, the credit reduces the amount of tax you owe.
Real Estate Taxes
With home improvements usually comes an increase in the appraised value of the house, which leads to higher property taxes. Property taxes are deductible on your income tax return. If you itemize your deductions, you can deduct the full amount of your real estate taxes.
Future Sale of Your Home
If you put money into improving your home, that increases the basis for determining whether you need to report any gain on the sale of your home. Your basis is determined by adding the price you paid for the home to the amount of money you paid to improve the home. If you lived in the home for at least two of the previous five years before the sale and the gain above the basis from selling the home is less than $250,000 if you are single or $500,000 if you file a joint return with your spouse, you do not have to pay any taxes on the gain provided you never used your house for business or rental reasons.