I understand capital improvements are added to the cost basis of a property if they are items that “adapt the home to new uses, prolong the home’s useful life or add value to the home.”
Big ticket items like kitchen/bathroom remodels, room additions, systems upgrades or replacements, etc. are clearly capital improvements and are therefore added to basis. Conversely, other expenses “necessary to keep the home in good condition, but don’t add to it’s value or prolong its life,” are not to be added to basis.
At issue is a client who sold a vacation home in 2020 for $520,000 that they purchased in 2014 for $375,000. Less closing costs, we are looking at a “preliminary” gain of +/- $110,000. (This home was never a rental just a vacation property for the family).
The waters get a bit muddy when, along with his 2020 tax documents, the client provided us with a handwritten list of “house expenditures” and insists that all these items be added to his basis.
While there was a kitchen remodel in the 6 years they owned the home, there were also repairs to the deck, fence and chimney, roof “reshingled to sell,” updated chandeliers, built-ins in the living room, new mailbox, new cabinetry in closets, new bathroom mirrors, etc.
In a discussion with the client, he says that he feels he can successfully argue in front of an IRS agent that ANY amounts spent on this home over the years “add to the value of the home and/or prolong its useful life.” His argument is that a buyer would want to decrease the purchase price of a home for a deck that is in disrepair or a fence that is falling down and that buyers will pay more for a house with updated chandeliers and wallpaper, thus those items can be seen as adding value to the home. I suppose I can see his point, but these items are all very contrary to my understanding of “capital improvements” that are typically added to basis
And of course, it doesn’t help matters that his list is all clearly estimated (all numbers end in 00 or 50): New blinds = $5000; New chandelier in living room = $2000; Wallpaper = $2500; Diming lights = $450; new Mailbox = $750; Misc = $2,500; etc. and he cannot locate any receipts, although he is now looking through old records. This list of items totals just under $75,000, which would take his taxable gain down to around $35,000.
And then to make matters yet even worse, he also provided us with a separate list of $26,500 worth of furniture (again, all numbers ending in 00 or 50) because he “sold the house furnished” BUT this is not mentioned or valued in any way on the Settlement statement or in any of the closing documents he provided to us. If we include the furniture in his adjusted basis figure, as he insists that we do, that takes his gain on sale down to around $8,500.
The client has said that he just wants to take his chances and if the IRS disallows his adjusted basis figure, then he will cross that bridge if/when he comes to it. I explained it isn’t exactly that simple for us and that if we take a position on a tax return, we need to be able to document it or back it up in some way other than his guesstimated lists.
Does anyone have any solid parameters or "rules of thumb" that might help navigate through the muddy guidelines the IRS provides us to assist clients in building their basis for a property sale? What can/should and can’t/shouldn’t be included in adjusted cost basis?
Thanks in advance for any advice on this.
Big ticket items like kitchen/bathroom remodels, room additions, systems upgrades or replacements, etc. are clearly capital improvements and are therefore added to basis. Conversely, other expenses “necessary to keep the home in good condition, but don’t add to it’s value or prolong its life,” are not to be added to basis.
At issue is a client who sold a vacation home in 2020 for $520,000 that they purchased in 2014 for $375,000. Less closing costs, we are looking at a “preliminary” gain of +/- $110,000. (This home was never a rental just a vacation property for the family).
The waters get a bit muddy when, along with his 2020 tax documents, the client provided us with a handwritten list of “house expenditures” and insists that all these items be added to his basis.
While there was a kitchen remodel in the 6 years they owned the home, there were also repairs to the deck, fence and chimney, roof “reshingled to sell,” updated chandeliers, built-ins in the living room, new mailbox, new cabinetry in closets, new bathroom mirrors, etc.
In a discussion with the client, he says that he feels he can successfully argue in front of an IRS agent that ANY amounts spent on this home over the years “add to the value of the home and/or prolong its useful life.” His argument is that a buyer would want to decrease the purchase price of a home for a deck that is in disrepair or a fence that is falling down and that buyers will pay more for a house with updated chandeliers and wallpaper, thus those items can be seen as adding value to the home. I suppose I can see his point, but these items are all very contrary to my understanding of “capital improvements” that are typically added to basis
And of course, it doesn’t help matters that his list is all clearly estimated (all numbers end in 00 or 50): New blinds = $5000; New chandelier in living room = $2000; Wallpaper = $2500; Diming lights = $450; new Mailbox = $750; Misc = $2,500; etc. and he cannot locate any receipts, although he is now looking through old records. This list of items totals just under $75,000, which would take his taxable gain down to around $35,000.
And then to make matters yet even worse, he also provided us with a separate list of $26,500 worth of furniture (again, all numbers ending in 00 or 50) because he “sold the house furnished” BUT this is not mentioned or valued in any way on the Settlement statement or in any of the closing documents he provided to us. If we include the furniture in his adjusted basis figure, as he insists that we do, that takes his gain on sale down to around $8,500.
The client has said that he just wants to take his chances and if the IRS disallows his adjusted basis figure, then he will cross that bridge if/when he comes to it. I explained it isn’t exactly that simple for us and that if we take a position on a tax return, we need to be able to document it or back it up in some way other than his guesstimated lists.
Does anyone have any solid parameters or "rules of thumb" that might help navigate through the muddy guidelines the IRS provides us to assist clients in building their basis for a property sale? What can/should and can’t/shouldn’t be included in adjusted cost basis?
Thanks in advance for any advice on this.
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