Private ruling: Rental property works
Published: May 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q1: Are you entitled to claim a deduction for expenditure incurred for repairs to rental property? | A1: No

Relevant facts and circumstances: You purchased a rental property at the time the property was tenanted. You did not perform a pre-purchase building inspection upon acquiring the property. You were aware at the time of purchase the bathtub needed resurfacing. You received a conditions report from your real estate agent shortly after purchase, which reported items that needed to be repaired or replaced.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 25-10 | Income Tax Assessment Act 1997 Section 43-10

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 ( ITAA 1997) provides that you may deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income, but not to the extent that it is capital, private or domestic in nature. Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature. Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) discusses the circumstances in which expenditure incurred for repairs may or may not be an allowable deduction under section 25-10 of the ITAA 1997. The word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. Works can fairly be described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time (paragraph 15 of TR 97/23). While some works may be fairly described as repairs, the expenditure will be considered capital in nature in some situations, and therefore not deductible under section 25-10 of the ITAA 1997. Expenditure incurred for repairs to property used for income producing purposes is of a capital nature where: 1. the works result in a greater efficiency of function in the property, therefore representing an improvement rather than a repair; or 2. the extent of the work carried out represents a renewal or reconstruction of the entirety, or 3. the work is an initial repair. | Detailed Reasoning - An improvement: An 'improvement' involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life. In your case, installing an item would be considered an improvement as it improves the overall use and functionality of the item. The fact that there was no item present at the time of purchase of the property increases the argument that by adding the item it enhances the market value of the property. | Detailed Reasoning - An entirety: TR 97/23 states that a thing or structure is more likely to be an entirety if it is an integral part, but only a part, of entire premises and is capable of providing a useful function without regard to any other part of the premises. The Ruling states that something that is part of a building, for example, a roof or wall, is just that and no more. The building itself is the entirety. In your case, the proposed repairs on your rental property would not be considered an entirety as the repairs alone are not capable of providing a useful function separate from the rental property itself. | Detailed Reasoning - Initial repair: If work is carried out to remedy defects, damage or deterioration that existed at the date of acquisition it is considered an initial repair and any expenditure incurred is considered capital in nature. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred. The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration: (a) existed at the time of acquisition of the property; and (b) did not arise from the operations of the person who incurs the expenditure. It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price reflected the need for repairs. An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer's assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property acquired. Initial repair expenditure relates to the establishment of the profit yielding structure. It is capital expenditure and is not deductible under section 25-10 of the ITAA 1997. In your case, the repairs proposed on your rental property are needed due to age and wear and tear. It is unlikely that in the short period since the purchase of the property that the repairs were all incurred. Had some of the repairs only appeared in the short period since purchase it is likely that they are a result of already present wear and tear on the property over time. As the proposed work is to repair existing defects when the property was acquired, the repair is considered an initial repair and therefore, capital in nature. As a result, you are not entitled to a deduction for the cost of the repairs on your rental property under section 25-10 of the ITAA 1997. | Detailed Reasoning - Capital works deduction: The proposed work carried out on your rental property is considered to be capital works for which a deduction is available under section 43-10 of the ITAA 1997. The relevant rate allowed for your capital works deduction is 2.5% per annum.