It’s my annual “Taxes from A to Z” series! If you’re wondering whether you can claim home office expenses or whether to deduct a capital loss, you won’t want to miss a single letter.
Z is for Zoning Costs.
When you dispose of a capital asset, typically by selling it, the result is a capital gain or loss. Most taxpayers understand that capital gains and losses apply to stocks and bonds but they apply to other kinds of property, too. For federal income tax purposes, a capital asset is any property that is expected to increase in value – not only stocks and bonds but real estate, collectibles, art, and cryptocurrency. Almost anything that you buy that isn’t intended to be consumed, used up, or immediately disposed of could be considered a capital asset (you can read the Tax Code’s definition of a capital asset here).
Sometimes when you have an emotional attachment to an asset, it’s hard to think of it as an investment. That tends to be the case with your house. Sure, it’s a home, but it’s also a capital asset. When you sell it, any gain over the exclusion amount of up to $250,000 for single taxpayers, or $500,000 for married taxpayers, may be taxable (unfortunately, you can’t claim a loss on your personal residence for federal income tax purposes).
You can’t typically deduct annual expenses associated with making your house more of a home, but there is a bright side: Some items that are not deductible as an expense may increase your basis. Your basis is typically the cost that you pay for assets, plus any adjustments. For capital gains purposes, your realized gain or loss is figured by calculating the difference between your sale price and your basis. So, the greater your basis, the less capital gain.
So what kinds of expenses could increase your basis? Zoning costs, including legal fees (that’s handy since legal fees for personal reasons are not typically deductible). Similarly, legal fees for defending and perfecting title may also be deductible.
What about improvements? Those increase your basis, too. When thinking about capital improvements, the Internal Revenue Service (IRS) uses the term “permanent improvement.” I explain it like this: Capital improvements tend to involve things you cannot (or would not) remove from the house. You can remove the new fridge or the plasma screen but you wouldn’t remove the wiring or plumbing, a new roof, or an addition. The cost of those improvements is added to your basis.
Here’s how the math works:
Let’s say that you buy a house for $300,000: That’s your cost basis. Let’s assume that you make a capital improvement to your home – not simply painting your bedroom or changing the drapes – in other words, a change that adds permanent value to your home (examples might include adding a second story or attaching a garage). That changes your basis. If that change costs you $50,000, then your new basis is $350,000: $300,000 (original purchase price) + $50,000 (adjustment to basis) = $350,000. When you sell the house, you now figure your gain based on the new, adjusted basis of $350,000.
For more on basis, check out IRS Pub 551, Basis of Assets (downloads as a pdf).
For your taxes from A to Z, here’s the rest of the series:
- A is for Annual Contribution Limits
- B is for Bonus
- C is for Choate
- D is for Direct Deposit
- E is for Enrolled Agent
- F is for Found Money
- G is for Ghost Preparer
- H is for Hobby Loss Rules
- I is for Installment Agreement
- J is for Joint Accounts
- K is for Kin (Crypto)
- L is for Line of Credit
- M is for Mileage
- N is for NIIT
- O is for Organ Donations
- P is for Private and Parochial Schools
- Q is for Qualifying Relative
- R is for Relief Funds
- S is for Surviving Spouse
- T is for Taxpayer Bill of Rights
- U is for Unused Sick Leave
- V is for Voluntary Bankruptcy
- W is for W-9
- X is for XE.com
- Y is for Yo-Yo Market