What is a capital improvement?

As a homeowner, you’ll invest far more into your property than just your mortgage, taxes, and insurance. Over time, you’ll repair or replace worn-out elements and make updates to keep your home looking modern, comfortable, and inviting.

Depending on how long you own your home, your goals, and the financing options available, you may also choose to make larger upgrades or additions—known as capital improvements.

In this guide, we’ll define and determine what qualifies as capital improvements. That way, you can better understand the potential benefits of enhancing your property.

What is a capital improvement?

A capital improvement is a permanent structural update that:

• Increases property value
• Extends the property’s useful life
• Supports a new or enhanced use
• May offer tax benefits
• Would significantly damage the property if removed

Projects like these can be undertaken by homeowners, businesses, or municipalities. Examples include:

• Adding a room, deck, or garage
• Renovating a kitchen, bathroom, or bedroom
• Replacing a roof, siding, or storm windows
• Installing a driveway, wall-to-wall flooring, fixed swimming pool, shed, built-in appliances, or solar panels
• Upgrading major systems, such as electrical, plumbing, or HVAC

Routine maintenance and minor repairs generally don’t qualify. Work that typically doesn’t count includes:

• Painting interior walls
• Installing a faucet or standalone appliance (washer, dryer, refrigerator)
• Fixing a leaky pipe or minor electrical issue
• Replacing a drawer handle
• Addressing normal wear and tear

In general, if a project doesn’t add significant value to the property, it isn’t considered a capital improvement. However, smaller repairs can count if they’re part of a larger upgrade—for example, replacing all windows rather than just one broken pane.

How a capital improvement works

Here’s a step-by-step overview of how a capital improvement project works, from the perspective of a homeowner:

1. You buy a property for $500,000 (the original cost basis) and then occupy it, rent it out, or both.
2. You decide to make a $50,000 capital improvement to the home six months later, such as adding a bedroom or completely renovating the kitchen and bathroom.
3. You hire a contractor to do the work (who may not need to pay sales tax on the lumber and supplies required to do the job).
4. Your home’s cost basis increases to $550,000 (the purchase price, plus the capital improvement investment).
5. You decide to sell the house five years later for $900,000, earning a $350,000 profit.
6. You’re single, so you would typically have to pay capital gains tax on $100,000 worth of profit ($250,000 is exempt). (If you were married filing jointly, up to $500,000 in profit would be exempt.)
7. Your $50,000 capital improvement project reduces the taxable amount to $50,000, saving you a tidy sum.

Important note: To qualify for the capital gains tax exemption, you must have used the property as your primary residence for two out of the last five years. That means you’re ineligible for this tax break if you sell a rental property (unless you occupied a unit, in which case, you should speak with your accountant for guidance).

How to finance a capital improvement project

Chances are, you don’t have tens of thousands of dollars sitting in the bank, waiting to be spent on capital improvement projects. In that case, you’ll need to borrow to fund the work. 

Fortunately, you have several financing options, including, but not limited to:

• Pool loans – Loans specifically for pool installation or upgrades. Typically repaid in fixed monthly installments over a set term. Usually require proof of income, good credit, and homeowners insurance.
• Home improvement loans – Personal loans for renovations, secured or unsecured. Repaid in fixed monthly payments over the loan term; interest rates vary by creditworthiness.
• Home equity loans – Lump-sum loans secured by your home’s equity. Fixed interest rates and predictable monthly payments over a set term. Requires sufficient equity, good credit, and often a property appraisal.
• Home equity line of credit (HELOC) – Revolving line of credit secured by your home’s equity. You can borrow as needed during the draw period and make interest-only or principal-plus-interest payments; repayment terms vary.
• Home equity investment (HEI) – You get a lump sum in exchange for a share of the home's appreciation. There are no monthly payments over a 30-year term. Instead, you repay the investment plus the agreed-upon percentage of the change in home value when you sell the home, refinance, or use another source of funds. Requires sufficient equity and a credit score over 500; there are no income requirements.
• Credit cards – Useful for smaller projects or short-term financing. Repaid monthly with interest unless using a 0% APR promotion; credit approval and sufficient credit limit are required.

The bottom line

Making a capital improvement to your home has several benefits. You’ll enjoy enhanced functionality and extended usefulness. Plus, you may be able to sell your house for more money and reduce your tax liability on the sale.

However, capital improvements are typically expensive. You’ll need to be sure that you’ll see a strong return on your investment – especially if you take on debt to finance the upgrades.