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Home improvements aren't cheap. Wouldn't it be nice if the federal government would help subsidize the cost? In a way, you can make that happen by claiming certain home-improvement tax benefits.
Medical home improvements
If you make improvements to your house based on the medical needs of yourself, your spouse, or a dependent, you can deduct the cost of those home improvements as a medical expense. Not surprisingly, the IRS has a few caveats for this deduction.
First, like all medical expenses, medical home improvements are subject to a 10% AGI floor. That means you have to calculate 10% of your adjusted gross income for the year, then subtract that amount from the total of your medical expenses. What's left over is the amount you can actually claim for the medical expense deduction.
Second, for medical home improvements, any increase to the value of your home is subtracted from the deduction. You might even need to get your home appraised after the home improvements are in place to determine how your home's value has been affected... which could unfortunately trigger an increase in your property taxes.
And third, you'll need to itemize instead of taking the standard deduction to get the benefit. Like all medical expense deductions, you'll claim medical home-improvement deductions on Schedule A of Form 1040.
Home office improvements
If you're eligible to claim the home office deduction, you can also deduct the full cost of any home improvements that affect only your home office area. For example, if you have just your home office recarpeted, you can deduct 100% of the costs.
Home improvements that affect your entire house can't be fully deducted as a home office deduction, but they can be partially deducted based on the size of your home office. For example, if your home office is 20% of the total floor space of your house and you install a new central heating system, you could deduct 20% of the cost of the heating system. You claim all home office-related expenses on Form 8829.
If you install solar panels or a solar water heater, you're eligible for the Residential Energy Credit (credits are even better than deductions, since they reduce your tax bill dollar-for-dollar). This tax credit will refund you 30% of the cost of a new solar-powered system, including installation costs. The Residential Energy Credit will be in effect through 2021, at which point it will be up to Congress to decide whether or not to renew it. To claim the Residential Energy Credit, file Form 5695 with your tax return.
All other home improvements
If your home improvements don't qualify for one of the special categories listed above, you're out of luck with regards to immediate tax benefits. However, you will get a tax benefit at the time you sell the house. You see, you can add the amount you spend on home improvements toward your cost basis in the house, and the higher your cost basis on the house, the lower your taxable gain will be when you sell it (if you sell it at a profit).
As a result, the money you spend on home improvements reduces your future taxable gain dollar-for-dollar. Note that you can only count costs for home improvements and not home repairs: Home improvements are defined for tax purposes as work that adds significantly to the home's value.
For example, say you bought your house for $200,000 and then made home improvements that cost you $50,000. You later sold the house for $600,000. Instead of being taxed on a gain of $400,000, you'd be taxed on $350,000 because of the increase in your basis from the home improvements. (This doesn't factor in the home sale tax exclusion, which you may or may not be eligible to claim).
If you're in the 25% income tax bracket you'd be charged a 15% capital gains rate, which works out to a savings of $7,500 in taxes. That's a pretty nice refund on the cost of putting in that second bathroom you just had to have.
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