Tax consequences of home additionsQ. I own my house free...

Q & A

January 31, 1993|By James Woodard/Copley News Service

Tax consequences of home additions

Q. I own my house free and clear and want to put an addition on it. Is it to my advantage to take out a new mortgage and thereby obtain the income-tax deduction, or should I pay for the addition by selling other investments I have?

A. "For a large number of people, it makes sense to finance your addition with a new mortgage, assuming you are in a position to itemize your deductions at tax time," said Warren Lasko of the Mortgage Bankers Association of America. "Consequently, your after-tax cost of mortgage borrowing likely will be lower than the return you would sacrifice if you sell your stocks and bonds."

IRS code favors 'permanent' remodeling

Q: We have lived in our home for 20 years and have made many costly improvements, some of which no longer exist. For example, we remodeled the kitchen twice and built a deck and spa that were later replaced by other landscaping. Now we are selling the house, and are wondering whether we may include the cost of the long-gone improvements in the home's cost basis to reduce our taxable gain from the sale. We have pictures and records to prove that the improvements were made.

A: The Internal Revenue Code allows taxpayers to include the cost of "permanent improvements" to a home in the residence's cost basis. The operative word is "permanent."

So you probably should not include these now-demolished improvements when you compute the cost basis of your residence. If you do decide to include the costs of the temporary remodeling -- on the theory that the IRS can't distinguish between a $30,000 kitchen overhaul and a $20,000 one -- be advised that this is considered potential tax evasion.

Deciding whether to pay down mortgage principal

Q: I am 35 years old, unmarried and make $22,000 a year at a job that has no retirement benefits. I own a home with a $60,000 loan balance carrying an interest rate of 9.4 percent.

Am I better off investing $1,200 in a tax-deductible individual retirement account or in using that money to pay down the balance on my mortgage?

A: It depends on how much risk you are willing to accept. If you invest in an absolutely safe investment -- a money-market fund -- the interest you earn will be considerably lower than the interest rate you pay on your mortgage -- even after the tax consequences are considered. So it would probably be wiser to pay down your mortgage principal.

But if you are willing to invest in a stock market mutual fund -- this is not necessarily risky, but neither is it absolutely fail-safe -- you could probably earn a high enough return to make opening an IRA worthwhile.

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