To answer your question:
1. You can add cost of improvement to calculate the capital gain. Cost of improvement does not include cost incurred in furniture, painting, etc. There needs to be structural improvement.
2. Yes, there needs to be proof of cost of improvement.
3. Yes, you can add the interest on housing loan as well. But please note, that this position is litigative and in case, your case gets picked up for assessment, then the assessing officer may take a different view.
4. You do have an option of selling the first property before April 2018. In this case, you can claim deduction against the purchase of the second house, which was bought in April 2017 (i.e. purchase of a property one year prior to the sale of the old property). Alternatively, you can invest in another house within 2 years (in case of constructed house) or 3 years (in case of under constructed house).
You can also invest in Capital Gain Bonds to save tax.
M.Com., CA, LL.B