Interest Tax Deductions

• You may qualify for a tax deduction if you pay for home improvements with funds from a mortgage, home equity loan or second mortgage. To qualify for the Internal Revenue Service's mortgage interest deduction, your loan must be secured by an instrument like a land contract, deed of trust or mortgage. The IRS only offers the mortgage interest deduction for loans on your primary or second home. At the time of publication, you can only take the deduction if you have a maximum total mortgage indebtedness of $1 million, or up to $500,000 if you are married filing separately.
  
  

Energy Improvement Tax Credits

• The IRS allows you to take a personal tax credit if you purchase certain Energy Star-approved products or install qualified renewable-energy systems on your home. The Energy Star tax program includes technologies such as insulation, windows, doors, water heaters, roofs, biomass stoves and heating and air conditioning equipment. You may also qualify for a tax credit if you install certain renewable-energy technologies, such as a solar water heater, geothermal heat pump, fuel cell, wind turbine or photovoltaic system. Your tax credit for energy-efficiency and renewable-energy home improvements may vary, depending on the year you purchase and install qualified equipment.
  
  

Capital Improvements

• Fixing up your home can raise its tax basis, depending on the type of improvement you make. The tax basis equals the amount of money you spend on your home, which can include the purchase price, interest and home improvements. Home improvements such as adding a swimming pool, installing central heating or building a garage typically constitute capital improvements. This means they increase the value of your property and its tax basis. When you sell your house, the home improvements you made may lead to a requirement to pay capital gains taxes.
  
  

Capital Gains

• The IRS levies capital gains taxes on profits from assets such as real estate, bonds and stocks. As of the 2010 tax year, you can sell your primary residence for a profit of $250,000 or less and avoid capital gains taxes. The tax-free amount increases to $500,000 if you are married and file jointly. These limits, however, only apply if you live in your home for a minimum of two years over the five year period prior to the sale. Past home improvement expenses can play an important role in reducing your capital gains requirements if you keep accurate and documented records of costs. While you may increase the value of your property through home improvements, you can often reduce your capital gains liability by including home improvement expenses in the tax basis.