Some of the least exciting things about real estate are the items which will save you lots of money in the end. The area where you will end up losing the most money is in the tax arena, where Uncle Sam gives few deductions and likes to take as many bucks as possible.

Fortunately, one of the best deductions available for most tax payers is their home – if they have a mortgage. The interest payments and property taxes are deductible. And when it comes time to sell the property, then the Great Tax Collector lets you exclude hundreds of thousands of dollars from the proceeds of the sale to reduce your gain, so that you’ll not pay as many taxes.

For single homeowners, the exclusion is $250,000; married couples filing jointly can walk away with $500,000 tax free from the sale of their home. With the national home sales average at $154,000, bypassing the tax man isn’t going to be that big a problem for most homeowners. But for those with property values a bit higher, there are tricks to the trade in determining the basis of your house.

The “basis” is the amount from which the IRS determines your gain to determine the capital gains tax. For the married couple, for instance, if their home sold for $750,000 (and they owned it free and clear) it would appear that they would owe taxes on $250,000 (the amount over the $500,000 deduction). Not so fast.

First, the IRS allows the owners to reduce their gain by the “basis” of their property. The basis is determined by how much it cost the homeowners to either build or acquire the property. If our retiring homeowners bought it 25 years earlier at $350,000, then they would reduce the $750,000 by that amount – now their gain is $400,000 – and it’s tax free because the gain is under the $500,000 married exclusion amount.

But what if it was a widow selling the same house. The $400,000 goes over the $250,000 for single homeowners. Subtract the $250,000 from the $400,000 gain and it would appear the homeowner must pay gains taxes on $150,000. Normally, she would then owe capital gains taxes on this amount, but the tax code allows for even larger reductions.

If you make capital improvements to your house, the tax code allows the owner to add those costs to the basis of the house. Repairs or regular upkeep expenses do not count as capital expenses, and therefore, cannot be added to the basis. The tricky part is determining which is which.

DISCLAIMER:Before you try calculating and deducting these items from your tax bill yourself, consult with a tax professional. I’m not a tax professional and unless you are, don’t do this at home – you could hurt yourself and your pocket book.

Now, on with the column: Some capital improvements that could be added to your basis include:

• Adding a new foundation or facade.
• Installing new floors or replacing current floors with tile.
• Replacing or reshingling the roof (but not repairing the roof).
• Installing a fire escape.
• Installing new wiring (but not replacing old or defective wiring).
• Replacing iron water pipes with copper.
• Converting your heating system.
• Remodeling the house.
• Enlarging or adding bathrooms.
• Installing landscaping or pool.

What these items have in common is that they are improving and increasing the value of an existing home. Expenses that repair or maintain a house, such as replacing an air conditioning compressor, fixing leaks in the bathroom sink, painting, plastering and papering the property, are all just regular maintenance and thus not excludable.

Now back to our example. If the widow above had replaced the iron water pipes, added bathrooms over the years, remodeled the interior, installed a pool and had the yard landscaped, and they all added up to $150,000, she could have added this amount to her basis (now it’s up to $500,000. Subtract that amount from the $750,000, and add in the $250,000 exclusion and she is tax free.

The key here is that she would have to substantiate all these expenditures, meaning she would have needed to hang on to all the receipts. The basis, while not a very sexy part of the real estate equation, can mean a lot when it comes to the final sale of the house and how much tax you will pay.

Published: February 15, 2002

Use of this article without permission is a violation of federal copyright laws.

Mr. Carr has covered real estate since 1989. He is the author of Real Estate Investing Made Simple. Got a personal real estate issue? Post your questions and comments at Anthony’s blog: commonsenserealestate.blogspot.com.