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Are Contract Labor Costs Tax-Deductible?

You cannot deduct payments made for contractor labor costs or any other expenses that arise in the construction of your new home in the current year. However, it is still important for you to keep track of these financial outlays for the future. Why? Because, if and when you decide to sell the home, these expenses can be used to increase your adjusted basi...s in the property and potentially lower your tax obligation.
Get a break on certain expenses

Remember, unless you meet certain requirements for excluding some of your gain, you are subject to taxes on any capital gain made on the sale of a home. You report the gain on Schedule D on your Form 1040. Expenses from property improvements, along with selling and administrative costs, can lower the capital gains on the sale of the property.

Make sure you keep track of all contractor invoices and building materials that you are incurring with the construction. The Internal Revenue Service states that your basis in the home is the cost of land plus the amount it cost you to complete the house, including the following.

The cost of labor and materials.
Any amounts paid to a contractor.
Any architect's fees.
Building permit charges.
Utility meter and connection charges.
Legal fees directly connected with building the house.

In addition, when it comes time to sell the home, keep records of any closing costs or Realtor fees incurred. These expenses will lower your capital gain and thus lower your tax obligation.
Use exclusion for primary residence?

Hopefully, you are planning on staying in the home for longer than two years. If so, the IRS has another perk to help offset any capital gains realized on the sale of the home, which is now considered a "primary residence." Single filers are allowed a $250,000 exclusion on any capital gains from the sale of a primary residence home. For those who are married filing jointly, this exclusion increases to $500,000. You have to have lived in the house two out of the previous five years ending on the date of the home sale and additionally have owned the home for at least two years. These are called the use and ownership tests.

There are some exceptions to the ownership and use tests for individuals who become disabled or if your previous home was destroyed or condemned. Additionally, if you are a member of the military, foreign service, employed in the intelligence community or in the Peace Corps and are on qualified official extended duty, special rules apply.

Finally, all hope is not lost if you fail to meet the ownership and use tests. You may qualify for a reduced exclusion amount due to health reasons, a change in the place of your employment or other unforeseen circumstances.

Important reminder regarding contract labor: Make sure you file Form 1099-MISC for any individual contractor that you paid more than $600 for services (including parts and materials) during the calendar year.

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