Remodel Your Way to Tax Deductions

You know that kitchen remodel you just had to have? Sure, it will impress buyers when you decide to sell, but it could also cut your capital gains tax burden.

If you have lived in your current home for two of the last five years, you're eligible for tax deductions when you sell. You can get up to $500,000 of your profit tax-free ($250,000 if single or married filing separately). But if you do a remodel that adds value to your home, the remodeling cost can be deducted from your capital gains.

Let's say you are single, and you bought your current home for $200,000. You do a $50,000 kitchen remodel and then sell your home for $300,000. You have only lived in the home for one year, so you're not eligible to get your profit tax-free.

"You can report that you gained only $50,000 on the home, and you'll only have to pay taxes on that amount," explains Alison Flores, a research analyst at the H&R Block Tax Institute.

So how can you claim these benefits? Here are some tips:

Only do a remodel that adds value to your home. "If you paint your living room three times because you can't decide on the color, the cost of the paint is not deductible," cautions Flores. Additions, landscaping, heating and air conditioning, plumbing and insulation -- when done right -- generally add value. For a list of deductible home improvements, see IRS Publication 523. Or, read about 10 ways to boost your home's value.

Document all your expenses. No one from the IRS is going to come over to admire your finished basement so keep your receipts. You can only deduct expenses for which you have a record. Your improvements affect the home's adjusted basis, so make sure you keep the records on hand for at least three years after you sell.

Always consult your tax adviser. For more information, visit the IRS Web site.