Recently, there was speculation that a certain politician should have paid Capital Gains Tax when selling their home. Critics argued that the home wasn’t their main residence, meaning they didn’t qualify for Private Residence Relief. However, some tax experts pointed out that they could have avoided CGT by making substantial improvements to the property. In light of this, we thought it would be useful to explain what improvements are allowed for Capital Gains Tax.
Capital Gains Tax and improvements
It’s worth pointing out that improvements don’t just apply to property. They can apply to any asset that is subject to CGT. For example, improvements to classic cars and works of art would be valid.
As a quick recap, if you sell a chargeable asset and make a capital gain, you may need to pay CGT. To calculate how much you pay, you need to do the following:
- Work out how much profit you’ve made (the difference between the purchase and sale price)
- Deduct from the profit any selling costs (such as solicitor or auction fees)
- Subtract from this sum the cost of any improvements you’ve made to the asset
- Deduct your CGT tax free allowance (normally £3,000 from April 2024)
So far, so good. But what improvements are allowed for Capital Gains Tax? Let’s look at what does – and what doesn’t – count as an improvement.
How improvements are defined
For HMRC to accept something as an improvement, it needs to meet three criteria.
- The improvement must be made to the asset. For example, if you paid for an artwork to be restored, this is an improvement to the asset itself. Therefore, you can deduct this cost from your CGT bill. However, if you pay for a dehumidifier to protect an artwork from damp, this is not an improvement to the actual asset. This cost can’t be deducted.
- The improvement must increase the asset’s value. For instance, if you added a conservatory to a rental property, this would increase its value. The cost can thus be deducted from CGT. Conversely, if you repointed the property or replaced missing roof tiles, these things would count as repairs rather than improvements. As a result the cost can’t be deducted.
- Is the increase in value still valid when you dispose of the asset? Let’s take the example of a classic car. If it had damaged paintwork and you got it resprayed, that would increase its value at the time of repainting. However, if you let the paintwork deteriorate again before selling, then the increase in value would not apply at the time of disposal. This would mean you couldn’t deduct the cost of repainting from CGT.
Keep evidence of the cost of improvements
Now we’ve looked at what improvements are allowed for Capital Gains Tax, we have a word of advice. It’s absolutely essential that you keep receipts when you pay for an improvement. Without them, you have no evidence of what you’ve paid. As a result, HMRC would probably not allow you to deduct the cost from your CGT bill.
Need more help with CGT?
If you need any help with CGT, we can help you. For example, we offer a Fast Track CGT service for property disposals. We can also advise you on CGT exempt assets, and any CGT allowances and reliefs that may apply to you. Simply get in touch with one of our friendly accountants today.
FAQs
Adding fees and closing costs as part of the selling costs will help determine your tax basis. Specific updates like home improvements can affect gain or loss. For example, if improvements such as a new roof, carpeting, pipes, or ductwork are made, the taxpayer can include those improvements in the calculation.
What home improvements can reduce capital gains tax? ›
These are called capital improvements. Some capital improvements include adding a room, appliances, floor, garage, deck, windows, roof, insulation, AC, water heater, ductwork, security system, landscaping, driveway, or swimming pool. All may qualify as improvements as they are meant to increase the home's value.
What improvements can be offset against capital gains tax? ›
For instance, if you added a conservatory to a rental property, this would increase its value. The cost can thus be deducted from CGT. Conversely, if you repointed the property or replaced missing roof tiles, these things would count as repairs rather than improvements.
What qualifies as a capital improvement for tax purposes? ›
Fixing a flaw or design defect, enlarging a building's capacity, retrofitting a building to improve energy efficiency, and rebuilding a building after it has reached the end of its economic life, all fall under capital improvements as per IRS rules.
What is a simple trick for avoiding capital gains tax? ›
A few options to legally avoid paying capital gains tax on investment property include buying your property with a retirement account, converting the property from an investment property to a primary residence, utilizing tax harvesting, and using Section 1031 of the IRS code for deferring taxes.
What expenses can be offset against capital gains tax? ›
Types of Selling Expenses That Can Be Deducted From Home Sale Profit
- advertising.
- appraisal fees.
- attorney fees.
- closing fees.
- document preparation fees.
- escrow fees.
- mortgage satisfaction fees.
- notary fees.
Yes, you can deduct qualifying home improvement costs from capital gains when selling your home. These costs add to the home's cost basis, which reduces the taxable gain.
Do you need receipts to prove capital improvements? ›
If the Internal Revenue Service audits you, agents may demand capital improvement receipts. The commission recognizes renovations improving the value of a home as a capital improvement, and IRS auditors usually require receipts.
What home improvements are tax-deductible when selling IRS? ›
Below are some of the medically necessary home improvements the IRS allows you to deduct:
- Installing entrance or exit ramps.
- Widening doorways.
- Widening or modifying hallways and interior doorways.
- Adding railings, support bars or other modifications to bathrooms.
- Lowering kitchen cabinets.
Just to confuse things, it should be noted that, according to the IRS, while painting is usually not considered a capital improvement, it must be capitalized if it is part of a large-scale improvement plan.
Since there is no age exemption to capital gains taxes, it's crucial to understand the difference between short-term and long-term capital gains so you can manage your tax planning in retirement.
How do I get zero capital gains tax? ›
Capital gains tax rates
A capital gains rate of 0% applies if your taxable income is less than or equal to: $44,625 for single and married filing separately; $89,250 for married filing jointly and qualifying surviving spouse; and.
What is the 6 year rule for capital gains tax? ›
Here's how it works: Taxpayers can claim a full capital gains tax exemption for their principal place of residence (PPOR). They also can claim this exemption for up to six years if they move out of their PPOR and then rent it out. There are some qualifying conditions for leaving your principal place of residence.
How can I reduce capital gains tax on my home sale? ›
How to avoid capital gains taxes on real estate
- Live in the house for at least two years. The two years don't need to be consecutive, but house flippers should beware. ...
- See whether you qualify for an exception. ...
- Keep the receipts for your home improvements.
For example, under Section 54, the maximum deduction that may be claimed is limited to 10 crores if the cost of the newly bought asset exceeds ten crores. Therefore, the exemption amount will be capped at ten crores in the event that the taxpayer acquires a new home for 18 crores and the gain amount is 18 crores.
What closing costs can be deducted from capital gains? ›
Of these, closing costs that can be deducted through the capital gains exclusion include: Title and abstract search and clearing charges. Title insurance. Filing or recording fees required by the jurisdiction(s)
