Advantages Tax Law Creates for Renovating Your Bath or Kitchen

July 15 was last week, and we realize that many of our existing and future clients in the San Francisco Bay Area just filed their 2020 tax returns. This week we will review the effects the 2018 tax law has on home improvements.

The amount of tax Americans pay is based on the amount of income they earn from their employment, investments and other sources, less permitted deductions and tax credits. Tax credits reduce the amount on your tax bill. The child tax credit of $2000 per child under 17 can be taken by single parents who make up to $200,000 annually and married couples whose income is less than $400,000 annually. A $1,000 tax credit will reduce your tax liability by $1,000, meaning that if your total tax liability is $10,000 and you have a $1,000 tax credit, the amount that you owe would be $9,000.

By comparison, a tax deduction lowers taxable income to an amount equal to your marginal tax bracket. If you are in the 32% 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 bath will have different tax consequences. The Internal Revenue Service (IRS) posted on 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 that if you use a home equity line of credit or second mortgage for your bath remodel, you can deduct the interest payments on those loans up to a certain limit. The 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 those expenses are not deductible. However, they 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.

Let’s look at that contextually. If you purchased your home in 1980 for $200,000, spent $50,000 renovating your bath in 2019 and $20,000 renovating a secondary bath in 2020, then the basis of your original purchase price for tax purposes would increase to $270,000.

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).

When you are considering a new 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. We would welcome the opportunity to show you how to make your dreams a reality by giving us a call at 415-621-4292 or visiting our showroom by appointment or virtually. Please note, consult a qualified tax expert before taking any action on the guidance in this week’s blog.