What Are Capital Improvements on a Home: IRS Tests and Basis Effects

Capital improvements on a home are permanent projects that add value to the property, extend its useful life, or adapt it to a new use. The IRS lets you add what you spent on those projects to your home’s tax basis, which lowers the taxable gain when you sell. Ordinary repairs do not get that treatment, so knowing the difference (and keeping the paperwork) is what turns a remodel into a tax saving years later.

The Three Tests

IRS Publication 523 sets out three benchmarks for a project to count as a capital improvement rather than a repair. A project only has to meet one.¹

It adds value. The work makes the home worth more, like a remodeled kitchen, an added bathroom, or upgraded flooring that raises market appeal.
It prolongs useful life. The project resets the clock on the home or a major system. A new roof or a new furnace is the standard example.
It adapts the home to a new use. Finishing an unfinished basement into living space, or converting a garage into a home office, qualifies.

The change also has to be permanent and stay with the property after you leave. Anything you can take with you when you move, like a freestanding appliance or portable shelving, does not qualify. And an improvement with a useful life of less than one year when installed does not count either.

Examples the IRS Accepts

Publication 523 groups qualifying projects into categories. The list is not exhaustive; any project meeting one of the three tests can qualify even if it is not named here.¹

Additions: bedrooms, bathrooms, decks, garages, porches, patios.
Lawn and grounds: landscaping, driveways, walkways, fences, retaining walls, swimming pools.
Systems: heating, central air conditioning, furnaces, ductwork, central humidifiers, central vacuums, air and water filtration, wiring, security systems, lawn sprinklers.
Exterior: storm windows and doors, a new roof, new siding, satellite dishes, insulation for attics, walls, floors, pipes, or ductwork.
Plumbing: septic systems, water heaters, water softeners, filtration systems.
Interior: built-in appliances, kitchen modernizations, new flooring, wall-to-wall carpeting, fireplaces.

One thing to watch: an improvement that is no longer part of your home cannot be counted. Wall-to-wall carpeting you installed years ago and later replaced does not stay in your basis.

Repair or Improvement?

Routine repairs keep the home in working order without making it more valuable or extending its life. Repainting a room, patching cracks, fixing a leaky faucet, or replacing broken hardware are repairs, and the IRS treats them as personal living expenses with no tax benefit.¹

Context can shift the label. Replacing a single broken window pane is a repair. Replacing that same window as part of a project to replace every window in the house makes the whole job, including the individual window, a capital improvement. The rule runs broadly: repair-type work done as part of an extensive remodeling or restoration project can be treated as an improvement.

Replacing Part of a System

When only a piece of a major building system is replaced, the question is whether the replaced piece is a major component or a substantial structural part. The IRS treats plumbing, electrical, HVAC, elevators, fire protection and alarm, gas distribution, and security as separate systems. Replacing a major component, such as the compressor in a central air conditioning unit, is a capital improvement. Replacing a minor part, like a single thermostat, is generally a repair.²

How Improvements Cut Your Tax When You Sell

Your home’s basis is the number the IRS uses to measure your profit when you sell. Start with the purchase price, add the cost of every qualifying capital improvement over the years you owned the home, and the result is your adjusted basis. Your gain equals the sale price minus that adjusted basis. Every documented dollar of improvement is a dollar less of taxable gain.

That matters because of the Section 121 exclusion. When you sell a primary residence, you can exclude up to $250,000 of gain if you file as a single taxpayer, or up to $500,000 if you are married filing jointly. To claim the full exclusion, you (or your spouse, if filing jointly) must have owned the home for at least two of the five years before the sale, and you must have lived in it as your main home for at least two of those five years. The ownership and use periods do not have to overlap, and you cannot have claimed the exclusion on another home sale within the previous two years.³¹

Improvements matter most for sellers whose gain is close to or above the exclusion. A larger basis pulls the gain down under the cap, and any gain that still spills over gets taxed at long-term capital gains rates.

Medical Modifications Follow a Different Path

Capital improvements made for medical reasons can be deducted as medical expenses rather than (or in addition to) added to basis. The IRS recognizes that certain accessibility modifications typically do not increase a home’s market value, and when that is the case, the full cost qualifies as a deductible medical expense. Publication 502 lists these modifications:⁴

Entrance and exit ramps
Widened doorways and hallways
Railings, support bars, and grab bars
Lowered or modified kitchen cabinets
Relocated electrical outlets and fixtures
Porch lifts and similar lifts (elevators generally do add value)
Modified fire alarms and warning systems
Modified stairways and door hardware
Grading the ground to provide access to the home

If a medical improvement does increase your home’s value, only the portion of the cost that exceeds the increase qualifies as a medical expense. Spend $20,000 on an elevator that raises the home’s value by $8,000, and $12,000 counts as a medical expense. Only reasonable costs for the medical purpose count; extra spending for cosmetic or architectural reasons does not.

Energy Credits Reduce Your Basis

If you claimed a federal energy tax credit on an improvement, such as the Residential Clean Energy Credit (Section 25D) or the Energy Efficient Home Improvement Credit (Section 25C), you have to reduce your basis by the amount of the credit. The credit offsets part of the basis increase you would otherwise get.⁵

Both credits have been eliminated for property placed in service after December 31, 2025. Homeowners who installed qualifying equipment before that cutoff may still claim the credit on their 2025 return, but no new credits are available for projects completed in 2026.⁶

Records to Keep

The tax benefit only works if you can prove what you spent. For each improvement project, hold onto:

Contracts showing the scope of work, the parties, and the agreed price.
Invoices and receipts for materials and equipment.
Proof of payment: canceled checks, credit card statements, or electronic payment confirmations.
Photographs or appraisals showing the nature of the improvement, which matter especially for medical modifications where you may need to show whether the home’s value went up.

Publication 523 advises keeping these records until at least three years after the due date of the return for the year you sell the home. In practice that means retaining improvement records for as long as you own the property, plus roughly three more years.¹ If you are not sure a project qualifies, keep the paperwork anyway. Discarding unneeded records later is easy; reconstructing costs from a decade ago is not.

1
Internal Revenue Service. Publication 523, Selling Your Home
2
Internal Revenue Service. Tangible Property Final Regulations
3
Office of the Law Revision Counsel. 26 USC 121 – Exclusion of Gain From Sale of Principal Residence
4
Internal Revenue Service. Publication 502, Medical and Dental Expenses
5
Internal Revenue Service. Instructions for Form 5695
6
Internal Revenue Service. One, Big, Beautiful Bill Provisions