Private ruling: Rental property deductions
Date of advice: 3 October 2024
Published: 11 November 2024
Ruling period: Year ended 30 June 20XX | Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Can you deduct the special levy expenses incurred for your rental property as maintenance under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Can you deduct your entire share of the special levy expenses as repairs under section 25-10 of the ITAA 1997? | A2: No. | Q3: Can you deduct the portion of your share of the special levy expenses that was incurred for concrete spalling repairs under section 25-10 of the ITAA 1997? | A3: Yes. | Q4: Can you claim capital works deductions for the remainder of your portion of the special levy expenses incurred for your rental property pursuant to Division 43 of the ITAA 1997 on completion of the works? | A4: Yes.

Relevant facts and circumstances: Several years ago you acquired an apartment (the Property) as tenants in common with another individual (Person B). The Property is used for income producing purposes and you still share 50/50 ownership with Person B. The Property is 1 of XX apartments in the building. Prior to the commencement of remedial works, you estimate the market value of the Property between $XXXX and $XXXX. The following documents provided with respect to the private ruling form part of, and are to be read with, the description of the facts and circumstances set out below. • Remedial Engineering Report dated XX XX 20XX • Tender Returns Breakdown Table dated XX XX 20XX • Remedial Engineering Scope of works dated XX XX 20XX • Minutes of the Annual General Meeting for the Body Corporate dated XX XX 20XX During the 20XX financial year, an engineering firm was retained by the Body Corporate following the identification of concrete spalling on the balconies. In the Tender Returns Breakdown of the works to be completed, the itemised costs incurred to the Special Levy include: • Preliminaries (including the establishment, Home Building Compensation Fund (HBCF), and access as required to complete scope of works). • Concrete spalling repairs • Improve balcony drainage • Re-waterproofing of the balconies • Cavity flashing works • Balcony door replacement • Construction of new balustrades to replace current ones effected by concrete spalling • External coating • Reinstatement and make good works. The Remedial Engineering Scope of Works document stated that they were engaged on behalf of the Owners to detail repair methodologies for the proposed remediation works to the balconies at the Property. At the time of purchase, you were not aware of concrete spalling. The Property was tenanted for XX weeks in the 20XX financial year. During the 20XX financial year, a Special Levy in the amount of $XXXX was raised by the Body Corporate. You contributed an amount of $XXXX towards the Special Levy. Remedial works are being completed across the balconies of all XX apartments in the building.

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

Reasons for decision: Detailed Reasoning - General deductions: The general deduction provisions of the tax law are contained in section 8-1 of the ITAA 1997. You can deduct expenses incurred for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature. | Detailed Reasoning - Application to your circumstances: In your case, you were required to pay a special levy to pay for a particular one-off expenditure. Maintenance expenses are periodic recurring expenses incurred to keep an asset in good working condition, such as oiling and cleaning. The contribution to the special levy is a substantial one-off expense that is not considered to be a maintenance expense that is deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Repairs and improvements: When considering the costs incurred and subsequently any allowable deductions, it is vital to distinguish between restoration of the item of property in question to its former condition (deductible) and improvement of the item (capital and thus not deductible). Section 25-10 of the ITAA 1997 provides that expenditure incurred by you for repairs to any premises, or part of premises, held or used by you solely for the purpose of producing assessable income is an allowable deduction. However, subsection 25-10(3) of the ITAA 1997 precludes a repair deduction if the expenditure is of a capital nature. The following are examples of expenses which are capital expenditure or of a capital nature: • Replacement of an entire structure or unit of property (for example such as a complete fence or building, a stove, kitchen cupboards or refrigerator). • Improvements, renovations, extensions and alterations; and • Initial repairs, for example, in remedying defects, damage or deterioration that existed at the date you acquired the property. Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction. TR 97/23 explains that 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired and contemplates the continued existence of the property. To repair property improves to some extents the condition it was in immediately before the repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10. It is necessary to consider whether the work done to property constitutes repairs by considering whether the work restores the efficiency of function of the property without changing its character. Repair is distinct from renewal or reconstruction; a repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety. Work done to part of a building, though not amounting to a replacement or reconstruction of an entirety may still be capital expenditure and not deductible, for example, because it amounts to an improvement. Paragraphs 44 to 57 of the TR 97/23 detail the distinction between a repair and an improvement. An improvement provides greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable and 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. The character of a repair does not necessarily change because it is carried out at the same time as an improvement. If some parts of the project can be effectively separated and considered in isolation from the rest of the project, they may still be repairs. In Wulf v FC of T [2022] AATA 3094 ( Wulf ), the AAT considered at length existing case law along with the guidance provided in TR 97/23 to arrive at the conclusion that some of the expenditures incurred by the taxpayer on their rental property were expenses whilst some other expenditures were capital improvements. The rental property was subject to water damage. It was found that the works undertaken had modernised from what it was prior to the water damage occurring. As a result, the materials on modernising the property were considered capital expenditure whilst other materials were considered repairs. In many repair processes, there is some improvement made to property as a result of technological advancements or more modern material. The greater the degree of technological advancement or enhancements arising due to the use of modern materials generally indicates the work completed is an improvement or change in the character of the property rather than a repair. | Detailed Reasoning - Capital works deductions: Division 43 of the ITAA 1997 provides that you can deduct an amount for capital works in an income year. Subsection 43-10(2) of the ITAA 1997, states that you can only deduct the amount if: (a) The capital works have a construction expenditure area; and (b) There is a pool of construction expenditure for that area; (c) You use your area in the income year in the way set out in Table 43-140 (Current use year). The deduction can be claimed for 40 years from the date construction is completed. The rate of deduction per income year is 2.5% Capital works also generally include improvements to buildings as stated in subsection 43-20(1) of the ITAA 1997. | Detailed Reasoning - Application to your circumstances: The Remedial Engineering Report found that there was inadequate waterproofing, cavity flashing and drainage in relation to the balconies and building façade, likely due to previous building standards when the building was first constructed and that are now outdated. It is recommended that, in addition to remedying the damage that had already been caused, these issues should be addressed in order to prevent future water damage. The Remedial Engineering Scope of Works refers to installing 32 scupper drains as part of a new stormwater drainage system to ensure adequate water discharge from the balconies and courtyards. The new waterproofing and cavity flashing will also be improved compared to what existed before the works. In addition, instead of replacing the pebblecrete and brick balustrades using like materials, you will be tiling the balconies and using metal and glass balustrades. This will significantly modernise the appearance of the building and would be expected to enhance its market value. Also, the special levy expense represents a substantial percentage of the market value of the apartment before the work was undertaken. Outlaying such a large portion of a property's current value is likely to result in more than an incidental or minor increase in the property's worth. We consider that the works undertaken to the Property do more than meet the need for restoration, The improved waterproofing, cavity flashing, and drainage will result in substantial savings in the future with respect to repairs and extend the useful life of the building. Some of the expenditure you have incurred is capital in nature, as the works undertaken are considered an improvement to the Property. In your case there was water damage to the property. Whilst some of the work conducted on your Property were to restore the damaged area to its previous condition (ie. the concrete spalling), some of the works were in the nature of an improvement where the damaged area was rebuilt with contemporary new fittings to modernise the Property from what it was prior to the water damage. As a result, we have considered that some items of your expenses are capital whilst other items would be considered repairs. The repairs related to the concrete spalling are deductible under section 25-10 of the ITAA 1997. The Tender Returns Breakdown Table provides you with a provisional sum in relation to the concrete spalling. You will have to apportion the final amount that is attributable to your property, when the final amount actually spent on remedying the concrete spalling can be identified and the Body Corporate can identify the actual expense incurred in remedying the defect. The improvements made to the balcony drainage, water proofing and cavity flashing; alongside the construction of new balustrades, balcony door replacements, and replacement of pebblecrete flooring with tiles, do more than meet the need for restoration. These expenses are considered capital works. The deduction can be claimed for XX years from the date construction is completed. The rate of deduction per income year is 2.5%.