Be Smart about Renovations in a Down Home Market

It's unlikely the real estate market will return to the fever pitch of the mid-2000s anytime soon – and maybe that's not such a bad thing. But even though homes are languishing on the market, it's not a bad time to make sensible renovations that will better position your property when times improve.

The idea is to discover the most affordable renovation ideas that produce the greatest returns in your particular market. And if you must borrow, do it sensibly. Evaluate the following:

Start with Your Credit Report

If you're considering borrowing, make sure your credit report and bill payment records are in the best possible shape. As in most economic crises, lenders go from being permissive to squeamish in an instant, so even people with good credit behavior are going to be under the microscope. Start by checking your credit report; you have the right to get all three of your credit reports – from Experian, TransUnion and Equifax – once a year for free. You can do so by ordering them at Annual Credit Report's Web site, but do so at staggered times throughout the year so you can catch potential errors in your report as they happen. Also, if you need to clean up any bad behavior – late bills, heavy credit card debt, clean it up before you wander back into the real estate market. It is very important to understand that a bad credit score can raise the total cost of your mortgage.

See What Kind of Payoff Your Chosen Renovation Will Have

During the housing boom, people thought virtually any renovation would offer big returns. That wasn't true then, and it's particularly untrue now. Take the time to figure out what renovations have the best chance for return on investment now. Whether it's renovating for a family need, an upgrade of the home's features, or for putting the home on the market always do a cost benefit analysis based on returns in your particular market.

Know How Long You'll Need to Stick Around

When you sell, remember that married couples, most likely, can exclude from their taxable income up to $500,000 of gain and individuals filing separately can exclude up to $250,000. It's required that you must have owned and used your home as your principal residence for two out of five years before the sale. The exclusion is generally applicable once in a two-year period. However, if you are unable to meet the two-year ownership and use requirements because of a change in employment, health reasons or unforeseen circumstances, then your exclusion may be prorated.

Beware the Bump in Property Taxes

The great thing about a more valuable home is the potential higher value when you sell. The bad thing is a visit from the county assessor – more valuable property tends to lead to higher tax assessments. Make sure you cannot only afford the cost of renovation, but what you'll need to pay higher taxes if your home is reassessed.

Don't Forget to Deduct Applicable Sales Tax

If sales tax was imposed on a major renovation or if your state or locality imposes a general sales tax on the sale of a home or the cost of a substantial addition or major renovation, you might be able to deduct it.  Consult IRS Publication 600 for more instructions. If a contractor is acting as your agent, the sales tax he pays on your major renovation may be deductible as well.

Make Sure Your Renovation Makes Your Home Salable

A discussion with a real estate agent or someone familiar with the value of improvements in your immediate neighborhood can tell you what will add to value or take it away. For instance, a big addition can take away from the value of a home if it's not aesthetically in tune with the rest of the neighborhood. Obviously, any renovation that keeps your house on the market longer better be worth it for your own comfort while you're living there because it may cost you later. Talk with a CERTIFIED FINANCIAL PLANNER™ professional to see how your improvement plans fit into your financial long-term goals and objectives.