Overview
When you invest in your home, not all costs are treated the same by the IRS. Capital improvements—projects that add value, prolong useful life, or adapt the property to new uses—are added to your home’s tax basis. By increasing your basis you reduce the taxable gain on sale. By contrast, routine repairs do not increase basis, and depreciation taken on rental property reduces basis and can cause depreciation recapture at sale.
This article explains how to identify qualifying improvements, how to calculate adjusted basis, and practical recordkeeping and tax strategies to protect your after-tax proceeds. It references IRS guidance (see IRS Publication 523 and Publication 551) and links to related FinHelp articles where useful.
Why basis matters
Adjusted tax basis is the starting point for computing capital gain when you sell:
Adjusted basis = Purchase price + Capital improvements – Depreciation – Certain credits or reimbursements
Capital gain = Selling price (less selling costs) – Adjusted basis
A larger adjusted basis means a smaller gain and potentially less tax. For primary residences you may also exclude part or all of the gain under the Section 121 exclusion (up to $250,000 single / $500,000 married filing jointly) if you meet the ownership and use tests (see IRS Pub. 523).
For more on the home-sale exclusion and how it interacts with improvements, see our guide: Capital Gains Exclusion on Home Sale.
What counts as a capital improvement vs. a repair
The difference is the heart of how improvements affect basis. Capital improvements typically:
- Increase the property’s value, or
- Prolong its useful life, or
- Adapt the property for a new use.
Common examples of capital improvements:
- Adding a room or garage
- Replacing a roof
- Installing a new HVAC system
- Major kitchen remodels (new cabinets, layout changes)
- Rewiring or major plumbing upgrades
- Replacing windows when designed to improve efficiency
Routine repairs and maintenance that generally do NOT increase basis:
- Painting
- Fixing leaks
- Patching plaster
- Minor plumbing or electrical repairs
The IRS provides examples and guidance in Publication 523 and Publication 551; when in doubt, treat a project as a capital improvement if it meaningfully adds value or extends life.
How to calculate adjusted basis — step by step
- Start with your purchase price (including closing costs that are part of basis, such as title search and legal fees related to the acquisition).
- Add the value of capital improvements (detailed invoices and receipts).
- Subtract any depreciation claimed (commonly applies to periods the property was used for business or rented).
- Subtract any insurance or other reimbursements tied to property damage or improvements.
Example — primary home:
- Purchase price: $200,000
- Capital improvements (kitchen remodel, new roof): $50,000
- Depreciation: $0 (owner-occupied)
- Adjusted basis = $250,000
- Selling price less selling costs: $350,000
- Capital gain = $350,000 – $250,000 = $100,000
If the owner qualifies for the Section 121 exclusion and is single, they could exclude up to $250,000 of gain and pay no capital gains tax on this sale.
Example — rental property with depreciation:
- Purchase price: $200,000
- Capital improvements: $30,000
- Depreciation taken over rental years: $40,000
- Adjusted basis = $200,000 + $30,000 – $40,000 = $190,000
- Selling price less selling costs: $300,000
- Capital gain = $300,000 – $190,000 = $110,000
Note: The $40,000 of depreciation will typically be subject to depreciation recapture rules on sale; unrecaptured Section 1250 gain on real property is taxed at a maximum rate of 25% (consult IRS guidance and your tax advisor for specifics).
Special issues and common complications
- Depreciation recapture (rental or business use): If you claimed depreciation, you must account for it on sale and may owe tax on the recaptured amount. See IRS guidance on depreciation and recapture (publication references below).
- Insurance reimbursements and casualty claims: Insurance proceeds that reimburse you for damage can reduce the basis if they compensate you for the loss; the interplay can be complex—document whether proceeds were used to repair or replace property.
- Improvements paid by another party or reimbursed by grants: Generally, amounts paid by others reduce the basis you can claim.
- Partial improvements and mixed-use property: If part of the property is rental and part owner-occupied, allocate costs appropriately and track depreciation on the rental portion.
Recordkeeping: the key to claiming basis adjustments
Good documentation is often the difference between getting the tax outcome you expect and facing an IRS adjustment. Keep:
- Contracts and paid invoices showing the work performed and materials used
- Cancelled checks or credit-card statements showing payment
- Building permits and inspection reports
- Before-and-after photos dated to show improvement timing
- Warranties tied to installations (helpful backup)
Store these records for as long as you own the property and at least three years after a sale. If you claimed depreciation, keep records for longer in case of audit or recapture issues.
Tax planning tips
- Track improvements in real time. Waiting until sale makes reconstructing costs hard and increases audit risk.
- Prioritize projects that both raise basis and improve sale value. Projects that extend useful life (roof, HVAC) are usually clear capital improvements.
- For rental owners, consider the tax tradeoff between taking depreciation now and higher recapture later. Depreciation reduces current taxable income but increases recapture on sale.
- Check for available tax credits for specific improvements (e.g., certain energy-efficient upgrades may qualify for credits). Credits are separate from basis adjustments; consult IRS guidance on energy credits and Form 5695.
How basis interacts with the home-sale exclusion
If you meet the Section 121 requirements (ownership and use for two of the five years before sale), you may exclude up to $250,000 ($500,000 MFJ) of gain on your primary residence. A larger basis from documented capital improvements lowers the gain you must compare to the exclusion, increasing the chance you’ll avoid tax entirely. Note there are special rules for short ownership, changes in use, and partial exclusions—see IRS Pub. 523 for details.
For more on calculating gains and the tax mechanics, including reporting requirements, see our related articles: Capital Gains and Schedule D (Form 1040) – Capital Gains and Losses.
Example checklist to prepare for a sale
- Collect and scan all improvement invoices and paid bills.
- Gather closing documents from purchase and sale.
- Total capital improvement costs by year and by project.
- Add selling expenses (agent commissions, closing costs) to compute net selling price.
- Review rental history and depreciation records if the property was rented.
- Talk to a tax pro to determine how exclusions and recapture rules apply.
Quick reference: typical capital improvements vs repairs
- Capital improvements: additions, new roof, major kitchen/bath remodel, full HVAC replacement, structural work.
- Repairs/maintenance: painting, minor patching, small appliance replacement, cleaning gutters.
Authoritative sources and further reading
- IRS Publication 523, Selling Your Home (explains basis, exclusions, and special rules): https://www.irs.gov/pub/irs-pdf/p523.pdf
- IRS Publication 551, Basis of Assets (detailed rules on basis adjustments): https://www.irs.gov/publications/p551
- IRS information on depreciation and rental property, including recapture: see Publication 527 (Residential Rental Property) and Publication 544 (Sales and Other Dispositions of Assets).
Professional disclaimer
This article is educational only and does not replace personalized tax or legal advice. Tax laws and IRS guidance can change. For a tailored analysis of your situation—especially when depreciation, insurance reimbursements, or complex improvements are involved—consult a qualified tax professional or CPA.
Final takeaway
Document every capital improvement, separate repairs from improvements, and include those qualified costs in your adjusted basis. A higher, well-documented basis reduces taxable gains when you sell and, combined with the home-sale exclusion, can often eliminate tax on appreciation for primary residences. For rental properties, remember depreciation lowers basis now and may increase tax later through recapture—plan accordingly.
