House sale capital gains tax handling of upgrades/renovations

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Dirghatamas
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House sale capital gains tax handling of upgrades/renovations

Post by Dirghatamas »

Short Version: Are all repairs/renovations/upgrades done within 90 days of house sale closing, deductible for capital gains taxes, or is there a specified list that is covered and those that are not?

Long Version: Moving from a house I have lived in/owned for 25 years to a downtown apartment (renting), so I can work remotely and walk to coffeeshops/restaurants/library/walking trails/farmers market instead of having to drive. First and only house I have owned so naive about house sales and taxes. House was built ~30 years ago.

I am moving/emptying the house this week and already hired a realtor and got inspection report done. Realtor gave me 3 options a) sell as is with no repairs b) sell with all external repairs/upgrades done c) sell with all internal and external upgrades done so house doesn't need anything from new owners for 10 years. Option a is 0 cost, option b is ~50-60K and option c is 100-120K. She thinks that while in todays hot real estate market, any of the options will sell, option c is best in terms of ROI. She thinks spending 100-120K on upgrades/repairs would bring in 150-170K in increased selling price. She doesn't know much about capital gain taxes and her calculations are before taxes. The 120K cost is no biggie for me in terms of affording it, this is just about financial ROI.

While I realize that realtors/contractors have a conflict of interest because they get paid as % of selling price (so would benefit if say I spend 100K but only get back say 90K), she comes highly recommended and is in the top 1% of realtors in the state in terms of total business last year. So, she knows the area and what features sell, very well. She even recommended some middle range changes rather than going high end for every change..so I am inclined to trust her.

My question is about the capital gains tax. Because I have lived there for 25 years, house prices have gone up a lot from my original cost basis and I am already beyond the 250K limit for real estate gains. I am always in the max tax bracket and that will be ~35-37% for long term capital gains (fed + state + NIIT). Even at an optimistic 35%, it means for every dollar I get back, I will only keep 65 cents unless I get to count the expenses as deductions.

I am getting confusing reads on this researching on the internet (I haven't yet reached out to a tax accountant about this). There is confusing info on what is considered an "upgrade" vs. "renovation" vs. "regular repairs". Further, some articles seem to suggest that if I get all this done within 90 days prior to house sales closing, then all these expenses will be part of the house sale itself and can be deducted. Other articles seem to suggest that some types of changes are tax deductible e.g. replacing whole roof while others may not be e.g. replacing all the carpeting.

The list of external changes she recommended are: new deck, new fence, new siding and external paint. For internal, she recommended new carpeting/flooring, complete new painting of the interior and new quartz countertops in the kitchen and bathrooms and new appliances in the kitchen.

I asked her why she thinks all these changes will be better than 1:1 ROI. In my simple brain, if we use the same contractor, the cost of repairs should be same for seller or buyer..She explained that an empty house (I will be moving out this week) is great for contractors/repairs while if we wait till the house is bought by new owners, they would have to delay moving in or find some other place to live during repair. Further, in todays expensive market, some buyers are stretched thin so they may have enough for mortgage down payment but not enough for a mortgage + say 100K in repairs.

As such, she thinks the best financial ROI for an owner who can afford it, is to renovate/upgrade everything after moving and then sell. I am somewhat nervous about this being optimal even before taxes and borderline skeptical about after tax ROI.
RubyTuesday
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Re: House sale capital gains tax handling of upgrades/renovations

Post by RubyTuesday »

Dirghatamas wrote: Sat Mar 19, 2022 6:31 pm Short Version: Are all repairs/renovations/upgrades done within 90 days of house sale closing, deductible for capital gains taxes, or is there a specified list that is covered and those that are not?

Long Version: Moving from a house I have lived in/owned for 25 years to a downtown apartment (renting), so I can work remotely and walk to coffeeshops/restaurants/library/walking trails/farmers market instead of having to drive. First and only house I have owned so naive about house sales and taxes. House was built ~30 years ago.

I am moving/emptying the house this week and already hired a realtor and got inspection report done. Realtor gave me 3 options a) sell as is with no repairs b) sell with all external repairs/upgrades done c) sell with all internal and external upgrades done so house doesn't need anything from new owners for 10 years. Option a is 0 cost, option b is ~50-60K and option c is 100-120K. She thinks that while in todays hot real estate market, any of the options will sell, option c is best in terms of ROI. She thinks spending 100-120K on upgrades/repairs would bring in 150-170K in increased selling price. She doesn't know much about capital gain taxes and her calculations are before taxes. The 120K cost is no biggie for me in terms of affording it, this is just about financial ROI.

While I realize that realtors/contractors have a conflict of interest because they get paid as % of selling price (so would benefit if say I spend 100K but only get back say 90K), she comes highly recommended and is in the top 1% of realtors in the state in terms of total business last year. So, she knows the area and what features sell, very well. She even recommended some middle range changes rather than going high end for every change..so I am inclined to trust her.

My question is about the capital gains tax. Because I have lived there for 25 years, house prices have gone up a lot from my original cost basis and I am already beyond the 250K limit for real estate gains. I am always in the max tax bracket and that will be ~35-37% for long term capital gains (fed + state + NIIT). Even at an optimistic 35%, it means for every dollar I get back, I will only keep 65 cents unless I get to count the expenses as deductions.

I am getting confusing reads on this researching on the internet (I haven't yet reached out to a tax accountant about this). There is confusing info on what is considered an "upgrade" vs. "renovation" vs. "regular repairs". Further, some articles seem to suggest that if I get all this done within 90 days prior to house sales closing, then all these expenses will be part of the house sale itself and can be deducted. Other articles seem to suggest that some types of changes are tax deductible e.g. replacing whole roof while others may not be e.g. replacing all the carpeting.

The list of external changes she recommended are: new deck, new fence, new siding and external paint. For internal, she recommended new carpeting/flooring, complete new painting of the interior and new quartz countertops in the kitchen and bathrooms and new appliances in the kitchen.

I asked her why she thinks all these changes will be better than 1:1 ROI. In my simple brain, if we use the same contractor, the cost of repairs should be same for seller or buyer..She explained that an empty house (I will be moving out this week) is great for contractors/repairs while if we wait till the house is bought by new owners, they would have to delay moving in or find some other place to live during repair. Further, in todays expensive market, some buyers are stretched thin so they may have enough for mortgage down payment but not enough for a mortgage + say 100K in repairs.

As such, she thinks the best financial ROI for an owner who can afford it, is to renovate/upgrade everything after moving and then sell. I am somewhat nervous about this being optimal even before taxes and borderline skeptical about after tax ROI.
Don’t know the answer but following for my future needs.

I will agree that option C provides the best ROI… for the realtor! :sharebeer
“Doing nothing is better than being busy doing nothing.” – Lao Tzu
Bmac
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Bmac »

With the caveat that I am neither a real estate professional nor accountant, it doesn't seem like there are very many home remodeling projects that increase the value by more than the cost of the project. So while you might sell for more and have somewhat more basis, the actual net profit will be less (to you, not the real estate agent).
WAROB
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Re: House sale capital gains tax handling of upgrades/renovations

Post by WAROB »

It will depend on the nature of the improvements if they will increase basis or be considered routine maintenance and upkeep.

I would lean toward selling it as-is. Clean it out and maybe do some painting or small repairs if need be. Undergoing 120k in repairs to just turn around and sell the house is a lot of work. What happens if a contractor takes off halfway through a project?

Buyers have different preferences and tastes so while I might spend a few grand on repairs and paint, I’d avoid taking on big projects.
Apathizer
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Apathizer »

Bmac wrote: Sat Mar 19, 2022 6:58 pm With the caveat that I am neither a real estate professional nor accountant, it doesn't seem like there are very many home remodeling projects that increase the value by more than the cost of the project. So while you might sell for more and have somewhat more basis, the actual net profit will be less (to you, not the real estate agent).
That's my understanding too. It's better to just sell the house as is for a little less. Home renovations/improvements usually cost more than they increase home value.
ROTH: 40% AVUS, 30% DFAX, 30% BNDW. Taxable: 50% BNDW, 30% AVUS, 20% DFAX.
HomeStretch
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Re: House sale capital gains tax handling of upgrades/renovations

Post by HomeStretch »

Your Realtor’s list of home repairs/updates seems overly ambitious and onerous plus may delay the listing. In my area, everyone seems to renovate after closing so there’s a chance that your upgrades are ripped out in a renovation by the Buyer.

As the Seller, I would make all repairs, clean well, paint, refinish floors, focus on curb appeal and replace anything that is an eyesore (such as a faucet where the finish has worn off) prior to listing. I would do any upgrades absolutely necessary to sell the house (i.e., replace/repair a failing septic system, replace leaking roof). I would not do any cosmetic upgrades nor delay the listing to renovate. The listing price would appropriately reflect condition and/or I would offer a credit at closing for perhaps an appliance at end of life.
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Nate79
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Nate79 »

Get at least 2 other realtors opinions. What yours recommends sounds crazy.
island
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Re: House sale capital gains tax handling of upgrades/renovations

Post by island »

I’m following too since it recently dawned on me that we’re sitting on a potential tax bomb due to large appreciation after living in same home for ~33 years in a desirable neighborhood in a HCOL area where demand far exceeds supply.
Realizing that makes is making it easier for me to accept how expensive it would be to do upgrades i’ve been thinking of for a few years, but hesitant to pull the trigger due to cost. We don’t plan to move anytime soon.

But if I was selling soon like you, I would not do all those upgrades recommended by your real estate agent. Seems excessive to me. Everyone has their own taste and if someone upgraded kitchen and baths with materials or colors I hate, I would not want to pay for it. As long as functional, i’d prefer something I wouldn’t feel guilty about tearing out once I decided what I wanted. And new counters on old cabinets are bad, just draws attention to the old cabs. Lipstick on a pig, as my mom used to say long before Sarah Palin wore it out. :D

Plus have you ever done that much remodeling? It can be a nightmare, with screwups and delays. Do u really need that hassle? IMO do what needs to be done to make it clean and presentable, fresh paint, new neutral carpeting, repairs and curb appeal, but leave the major design stuff for the next owner to decide.

And agree w getting more opinions from other real estate agents.

Please let us know what u decide and how it worked out!
Normchad
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Normchad »

I would just repair anything that is broken, and clean and stage the house.

I don’t trust your realtors assessment of potential home value increases with option C. But even if they are right, I wouldn’t invest $120K to net an extra. 30 to 50K. If 120k isn’t a biggie to you, neither is 50K.

People need to catch in to the terrible line of thinking. Spending 100K on a home renovation won’t ever make you money. I think the only time it will is you somehow do all the labor yourself. The HGTV shows just aren’t realistic.
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tetractys
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Re: House sale capital gains tax handling of upgrades/renovations

Post by tetractys »

There are many stories about sellers making big improvements only to see buyers immediately tear them out to remodel. Certainly there are lists of best and worst practices to boost sale value.

It’s in the interest of the real estate agent to sell your house higher for a better commission; but they would not necessarily care how much comes out of your pocket to get there.
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sergeant
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Re: House sale capital gains tax handling of upgrades/renovations

Post by sergeant »

Do not go the renovation route. Sounds like kookbabble from the real estate agent. Is her husband a contractor?
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Big Dog
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Big Dog »

I understand the Realtor's concept, but that is a whole lotta work for just an extra $30-$50k net. Plus, it will take months to complete. If you can't get 3x in return on your $120k, i.e., $300k+ in increased sales price, the effort is not worth it, IMO.
LeftCoastIV
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Re: House sale capital gains tax handling of upgrades/renovations

Post by LeftCoastIV »

tetractys wrote: Sun Mar 20, 2022 12:40 am It’s in the interest of the real estate agent to sell your house higher for a better commission; but they would not necessarily care how much comes out of your pocket to get there.
This. It doesn’t cost the realtor anything to recommend this, and they benefit while you carry the risk. Fresh paint, cosmetic repairs, address likely home inspection issues, and refresh the front landscaping, then let the buyer decide how to upgrade after closing.
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Dirghatamas
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Dirghatamas »

Thanks everybody so far.

I have read through all responses but replying collectively because in effect ALL responses so far have been the same: it is difficult to make home renovations/upgrades beat 1:1 in final asking price so why bother figuring out tax consequences when the before tax ROI itself isn't justified.

I would still like to get my capital tax question answered by any knowlegeable folks who went though a similar situation of house renovation/upgrades/repairs


I am a bit surprised that there is such heavy consensus. I am completely naive about real estate having only bought and lived in one house for 25 years..so learning. I reached out to the realtor and she sent me back several actual examples of houses+ renovation work she recommended/got done/sold in the last year. She insists that the ROI is much > 1:1 in our area in today's market. The listings are all verifiable and I went through a couple today morning. What is difficult is to discern how much the houses would have sold for if the owners had NOT done the renovations she recommended and instead sold them as is or with minimal cosmetic things. So, there is no independent method to verify her claims about ROI. She DID also send me other houses which she sold last year without much upgrades. Looking at it just as $/sq ft, her claim seems to make sense but again there is no control experiment as each house is different.

She also explained in her email today in longer detail WHY the ROI works this way financially (at least in our area in this hot market) so I at least now fully understand her math. According to her, house prices in our HCOL area are now high enough that people are having to stretch financially to buy and make the down payment. For a house that requires no repairs or upgrades, the only money they need right away is the down payment. For a 30 year loan, they are OK as long as the monthly mortgage payment is not too excessive compared to monthly income.

However, repairs are different. Without a loan specifically for repairs (apparently called a rehab loan that is a lot more complicated than a straight mortgage loan), they have to pony up the entire amount right then, just after having already paid a large sum (as down payment). That may not be workable for many potential buyers. If instead the repairs are already done and the price raised accordingly, their down payment and monthly mortgage goes up slightly but they don't need to for example have 50-100K in cash right away. As an example, if we do 100K in renovation and increase asking price by 150K, then 150K is distributed across a 30 year loan then that is just 5K per year (other than interest). For a cash stressed buyer, 150K over 30 years is easier to handle vs. 100K today, even though the repair costs are the same. The seller (in her view) pockets the 50K for their short term (1-2 months) 100K investment

That's her main point: if the house is sold as is, the type of people who will bid are "flippers" who have the cash to do the repairs but will typically want a large discount. Ordinary mom and pop type buyers would (in her view) bid up the prices of completely move in ready houses (houses are in very short supply in our area).

I am going to take a pause for a couple of days and get a second opinion from some friends who sold recently in the area. I am quite green in this field and doing something hasty could be risky.

Given the focus of this forum, I would still like to get any tax advice/knowledge about this situation: if I do decide to do some renovation (either all or a part of what she recommended), just before sales/closing, how do capital gains taxes work? Do I get to discount all the renovation/repair/upgrades and increase my cost basis or is there a guideline from IRS or other reputable source on what expenses (repair/renovation/upgrade) just before house sale are deductible.
WAROB
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Re: House sale capital gains tax handling of upgrades/renovations

Post by WAROB »

What specific upgrades is the realtor pushing for? Is your home outdated or in need of major repairs?

IRS publication 523 is what you are looking for as to what increases your basis. Page 8 has a list of improvements that qualify.

Things like painting or fixing leaks don’t increase your basis but putting on a new roof would.

I’d type in your address on Zillow, select sold, zoom in and look for comps in your neighborhood area. Look at the pictures and see if you can find similar era homes that have been updated vs those that haven’t. Should help get an idea of what people are paying for homes similar to yours.
Big Dog
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Big Dog »

I get what your realtor is saying as I just went thru this when I sold my childhood home when my dad passed in Oct-20. Market in the Bay Area was heating up and the realtor was a long-time friend so he was completely up-front. Said home was worth $1.2-$1.3m as-is. Good bones, but needed a lot of work. If we upgrade, it would cost $80k+, but he would then list at $1.4m with a goal of selling beyond $1.5m. But he also acknowledged that it was not worth the hassle upgrading during covid to only get the $1.4m. (lotta work and time, not to mention it was an old house and who knows what we'd find when we start demo work. Plus,the $100k increase is not a guarantee.) With interest rates rising, your market might be stabilizing.

As for your tax question, there are plenty of article available upon searching. Yes, major improvements increase your cost basis. Here's a couple:

https://www.millionacres.com/real-estat ... ost-basis/

https://finance.zacks.com/repainting-in ... -1515.html
exodusNH
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Re: House sale capital gains tax handling of upgrades/renovations

Post by exodusNH »

Dirghatamas wrote: Sat Mar 19, 2022 6:31 pm Short Version: Are all repairs/renovations/upgrades done within 90 days of house sale closing, deductible for capital gains taxes, or is there a specified list that is covered and those that are not?

Long Version: Moving from a house I have lived in/owned for 25 years to a downtown apartment (renting), so I can work remotely and walk to coffeeshops/restaurants/library/walking trails/farmers market instead of having to drive. First and only house I have owned so naive about house sales and taxes. House was built ~30 years ago.

I am moving/emptying the house this week and already hired a realtor and got inspection report done. Realtor gave me 3 options a) sell as is with no repairs b) sell with all external repairs/upgrades done c) sell with all internal and external upgrades done so house doesn't need anything from new owners for 10 years. Option a is 0 cost, option b is ~50-60K and option c is 100-120K. She thinks that while in todays hot real estate market, any of the options will sell, option c is best in terms of ROI. She thinks spending 100-120K on upgrades/repairs would bring in 150-170K in increased selling price. She doesn't know much about capital gain taxes and her calculations are before taxes. The 120K cost is no biggie for me in terms of affording it, this is just about financial ROI.

While I realize that realtors/contractors have a conflict of interest because they get paid as % of selling price (so would benefit if say I spend 100K but only get back say 90K), she comes highly recommended and is in the top 1% of realtors in the state in terms of total business last year. So, she knows the area and what features sell, very well. She even recommended some middle range changes rather than going high end for every change..so I am inclined to trust her.

My question is about the capital gains tax. Because I have lived there for 25 years, house prices have gone up a lot from my original cost basis and I am already beyond the 250K limit for real estate gains. I am always in the max tax bracket and that will be ~35-37% for long term capital gains (fed + state + NIIT). Even at an optimistic 35%, it means for every dollar I get back, I will only keep 65 cents unless I get to count the expenses as deductions.

I am getting confusing reads on this researching on the internet (I haven't yet reached out to a tax accountant about this). There is confusing info on what is considered an "upgrade" vs. "renovation" vs. "regular repairs". Further, some articles seem to suggest that if I get all this done within 90 days prior to house sales closing, then all these expenses will be part of the house sale itself and can be deducted. Other articles seem to suggest that some types of changes are tax deductible e.g. replacing whole roof while others may not be e.g. replacing all the carpeting.

The list of external changes she recommended are: new deck, new fence, new siding and external paint. For internal, she recommended new carpeting/flooring, complete new painting of the interior and new quartz countertops in the kitchen and bathrooms and new appliances in the kitchen.

I asked her why she thinks all these changes will be better than 1:1 ROI. In my simple brain, if we use the same contractor, the cost of repairs should be same for seller or buyer..She explained that an empty house (I will be moving out this week) is great for contractors/repairs while if we wait till the house is bought by new owners, they would have to delay moving in or find some other place to live during repair. Further, in todays expensive market, some buyers are stretched thin so they may have enough for mortgage down payment but not enough for a mortgage + say 100K in repairs.

As such, she thinks the best financial ROI for an owner who can afford it, is to renovate/upgrade everything after moving and then sell. I am somewhat nervous about this being optimal even before taxes and borderline skeptical about after tax ROI.
Sell as-is. Supply chain is still out of whack. Your first, second, and third choices will be out of stock. There will be price increases.

Even if you get more back than you invest, it won't be worth the hassle. Do you really want to manage bids, keep tabs on the contractors, sign off on the inevitable change orders, and, even worse, find an expensive problem that you then need to rectify?

Even if your repairs add to the basis, it doesn't help reduce the capital gains tax. If anything, if you put in $100k and get an additional $150k, you've now got another $50k of capital gains! And if you don't get back your investment, you've lost money! It makes no sense to lose money to avoid taxes.

Take your $250k gift from the US government, pay the capital gains on the balance, and enjoy not owning a home.
lazynovice
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Re: House sale capital gains tax handling of upgrades/renovations

Post by lazynovice »

Here is the IRS publication on home sales. Page 16-17 discuss what can increase your cost basis. And what is a repair versus an improvement.

https://www.irs.gov/pub/irs-pdf/p523.pdf

You will also see that the 90 day rule is not mentioned there. That was related to fixing up expenses and went away in a tax code rewrite in 1997 AFAIK.

https://www.investopedia.com/terms/f/fi ... penses.asp

I was surprised to hear you quoting it and equally surprised to see many references to it with a Google search.

I am in the crowd who will tell you not to do any cosmetic repairs. There is a strong chance it will get ripped out by the buyers. I would make repairs to things they might find on their inspection and cause them to walk away from the contract. If buyers are waiving inspection in your market then you might not need to do that provided you disclose everything you know.

Lining up contractors in our experience right now is difficult. Many are booked weeks out. The supply chain is just waking up. Interest rates are going up. I’d take my guaranteed return before putting money into a house with the hope that it would pay me back.

There are a lot of things you can do to make a house show better. Staging, decluttering, etc. They are mostly free. Do those.
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Dirghatamas
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Re: House sale capital gains tax handling of upgrades/renovations

Post by Dirghatamas »

I wanted to update this thread, now that my house sale closed earlier in June and I have a much better understanding of both the renovation and taxes. Hopefully it can help others in the future.

My original question was about the handling of capital gains taxes vis a vis large home renovations prior to sale. Most replies argued that instead of worrying about taxes, focus should be on renovation: does it make sense and have sufficient ROI? The consensus advice was to do the minimum and basically sell "as is" especially in a hot market.

My realtor insisted that ROI of an upgrades house is typically much better than 1:1. Being completely naive about real estate, I went with the realtor's recommendation and ~ 3months later, the process is complete.

Overhead: The actual renovation and house selling process was smooth as could be. Everything was done electronically and I literally didn't need to visit the house even once during the entire renovation/house staging/sale closing period which lasted almost 3 months. The realtor and contractor took care of everything. I was updated with pictures regularly. There were some setbacks but not dealbreakers. The bill came in ~2K higher than anticipated and there was a delay of ~10 days waiting on some material supplies that were out of stock. Given the COVID related supply chain issues and inflation, I didn't make a big deal out of this.

Sale: Due to renovation, the sale had to be shifted by ~2 months. Market in our area started cooling a bit due to higher interest rates. The house got offers within a day of listing and we accepted the best offer (among several) after the listing weekend. Unfortunately, the offers were just inline with the neighborhood $/sq ft. The fact that all the renovation means new buyers wouldn't need to do any repairs or replacements in the next 10-15 years..seems to not have much impact.

The realtor felt prospective buyers may be getting "topped out" due to interest rate changes and simply couldn't bid high to justify the upgrade costs (to me). I decided that accepting the offer after initial weekend was prudent, rather than waiting for an extended period for a higher offer. Rest of closing process took a month and was uneventful. The realtor was highly competent and took care of everything. Very smooth.

Financial ROI: For the ~120K investment to renovate, I don't think I came anywhere close to 1:1. I think even 0.5:1 maybe optimistic. People in my location appeared to want houses there due to employers and school district. Thinking that they may save a LOT over time (because all repairs and upgrades for next 10-15 years were already done) didn't seem to matter much. I don't have any reason to believe the realtor was being dishonest. She came across as a highly competent and hard working person so it is possible the market changes (interest rates going up) changed the market dynamics with buyers getting topped out. Still, given this experience my advice would be to NOT do a significant renovation prior to sale and sell a house "as is" with perhaps some small cleanup or fixing obvious eyesores or safety related issues.

Taxes: I consulted a CPA. My understanding based on googling was completely wrong (as already pointed out by folks above in this thread). There USED to be some time period (90 days before sale) that was handled in a special fashion for taxes a long time back (prior to 1997). Still, if you search/google this topic, you will get numerous articles stating that as current law, which is flat wrong... As per current law, the date of renovation doesn't matter. Whatever capital upgrades you make after buying and before selling a house count as tax deduction so there is no special period. Repairs are different from any capital upgrades and same upgrade can't be used multiple times e.g. if you owned a house for say 40 years and replaced the roof twice, only the last one counts..

Overall, I learned a fair bit about the real estate sale process and taxes. While I lost some money (maybe 40K-70k), it wasn't a huge deal for my financial picture and the sale process was very efficient and low stress.
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