"Functionally Obsolescent Due to Super-Adequacy," is what it's known as by appraisers. An over-improvement is where you have put more money into your house than you can ever hope to get back when you sell it. You can also find yourself upside-down in your house at the time of sale, because the home equity loan you got to do these improvements comes due in full at the moment of resale. So, how do you avoid this situation?
Take a look at your neighborhood and get a feel for what's normal in the area. You can work with a realtor to get comparable sales prices, an assessment of the home's market value with the improvements, and the maximum sales price of similar homes on the block. If your assessment comes in above the max sales price, you should stop any projects that you have planned. You don't want to improve beyond the norm of the neighborhood. You can bring your home up to par, but not beyond.
There are a few ways to make sure you won't fall into this trap. One easy way to avoid over-improving is to stay away from top-of-the-line appliances and finishes as buyers don't want to pay for others' extravagance. You also don't want to add square footage beyond the biggest house in your neighborhood. If you're looking to finish off a part of your house, go for the attic over the basement, as above-grade living spaces are more desired by buyers than sub-grade.
Home offices, new sunrooms, upscale master suites, and pools will get you the least return on your investment. Minor kitchen remodels, bathroom additions, major kitchen remodels, family room additions, two-story additions, attic bedrooms, moderate master suites, and bathroom remodels will be the most likely to pay you back on resale.
If you're in a unique, non-conformist property, it may be hard to get comparables, so it's good to talk with a realtor before starting any renovations or improvements. Also, if you're planning to live in your house until retirement or longer, over-improvements may still pay off over time, especially if it's something that you and your family really enjoy.
Sources: realestate.msn.com, insidesfrealestate.com, lifeorganizers.com, realtor.com, therenovationguru.com