Private ruling: Deductibility of legal expenses
Date of advice: 22 June 2018
Published: September 2018
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you entitled to a deduction for legal expenses associated with your rental property? | A1: No. | Q2: Do the legal expenses form part of the fourth element of the cost base? | A2: Yes.

Relevant facts and circumstances: The local council has taken you to court because you indicated that you would be building a fence along the boundary of your rental property. The fence has been requested by the tenants as there had been a number of break-ins and occurrences of strangers and animals wandering onto the property causing damage. The council claims that because they have an easement over part of the property you cannot build the fence.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Section 110-25

Reasons for decision: Summary: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction 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, or relate to the earning of exempt income. Expenditure is capital in nature where it is made with a view to bring into existence an asset or advantage that is of enduring benefit. Capital expenditure is characterised by the fact that it is usually a one-off payment and establishes, replaces or enlarges the income producing asset. The legal fees you have incurred are associated with the ongoing court case where you are arguing your right to erect a fence/gate structure along the boundary of your property because your tenants’ vehicles and homes had been broken into. The nature of the expenditure relates to the protection of your property by erecting a fence which will ‘bring into existence an asset or advantage that is of enduring benefit’ to your property and your tenants. These fees are an outgoing of a capital nature and so do not allow a general deduction under section 8-1 of the ITAA 1997. | Detailed Reasoning - Cost base: As the expenditure is a capital expense, which is not deductible, we need to consider whether the expenditure can form part of the cost base of your rental property. Subsection 110-25(5) of the ITAA 1997 states that the fourth element of the cost base for CGT purposes is capital expenditure you incurred, the purpose or expected purpose of which is to increase or preserve the asset’s value. It is reasonable to expect that the legal expenses associated with your desire to erect a protective fence along the boundary of your rental property may increase its value and therefore you would be able to include the cost incurred as part of the fourth element of cost base for capital gains tax purposes under subsection 110-25(5) of the ITAA 1997.