Private ruling: Income Tax – Deductions – Rental Property
Date of advice: 11 September 2017
Published: January 2018
Ruling period: Year ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled an immediate deduction for the following expenses? ● turf, ● replacement of doors, ● repairs to flooring, ● removal of trees, and ● the costs incurred to restore the bathroom ● the replacement of a power pole | A1: Yes. | Q2: Are you entitled an immediate deduction for the expenditure incurred in replacing kitchen cabinets? | A2: No.

Relevant facts and circumstances: Prior to 1985, you built a property (the property). In 19xx you decided to rent the property which was in new condition and had an established garden. The property was been rented for the majority of time you held ownership. In 20xx, the property became vacant after being rented by the same tenant for many years. You did not inspect the property during this time. The property and garden had deteriorated over time and required significant repairs to restore it to the initial condition as a result you were unable to rent the property while it was in this state. You and a family member carried out repairs to the property until 20xx . It was at the time that you received treatment for an injury and illness. Due to your injury and illness you decided that you would not be able to manage and maintain the property so you decided to sell the property. Your family member continued the repairs with the help of professional tradesman’s at times. The repairs completely restored the house to its previous condition without any improvements. The property is located within a bush fire risk zone. Due to the location of the property you received advice from Fire Services to remove trees within the vicinity of the property to diminish a fire risk. A power authority issued you with a defect notice and deemed that the wooden private power pole at the premises was a bush fire safety risk. The defect notice requested the pole be replaced with a metal power pole. You incurred an expense to replace the kitchen cabinets. You replaced the following items in the bathroom; ● Shower screen, ● Bath, ● Vanity, You incurred an expense for the removal of trees close to the property due to the fire risk. You incurred a cost for the purchase turf. You incurred a minor cost to repaint the floor of the kitchen. You incurred a cost to replace the doors in the property. You have not received insurance proceeds and did not make a claim to the tenant’s bond money.

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 | Income Tax Assessment Act 1997 - Section 43-10 | Income Tax Assessment Act 1997 - Subsection 43-25(1)

Reasons for decision: Detailed Reasoning - Repairs, capital improvement and a replacement of an asset in it’s entirely: Section 25-10 of th e Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature. Expenditure incurred to remedy defects, damage or deterioration in existence at the time property is acquired is an initial repair and not deductible under section 25-10 of the ITAA 1997. The ATO guide for rental property owners, Rental properties 2017, states that costs of repairs may be deductible if a rental property is unoccupied provided that the need for repairs relates to the period in which the property was used to produce income and that the property was producing income during the income year that the costs were incurred. Taxation Ruling TR 97/23 provides guidelines on the deductibility of repairs. Generally, a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. Works can be fairly described as ‘repairs’ if they are done to make good a defect in, damage to or deterioration of property that has occurred by ordinary wear and tear, by accidental or deliberate damage, or by the operation of natural causes during the passage of time. Renewal or reconstruction, as distinguished from repair, is restoration of an entirety. An entirety is defined as something separately identifiable as a principal item of capital equipment ( Lindsay v. Federal Commissioner of Taxation (1960) 106 CLR 377; (1960) 12 ATD 197; (1960) 8 AITR 99). As per paragraph 38 of TR 97/23 property is more likely to be an entirety if: ● the property is separately identifiable as a principal item of capital equipment; or ● the thing or structure 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; or ● the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or ● the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law. 39. Property is more likely to be a subsidiary part rather than an entirety if: ● it is an integral part of some larger item of plant; or ● the property is physically, commercially and functionally an inseparable part of something else. An improvement provides a greater efficiency of function and involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. If the work done restores a previous function, or restores the efficiency of the previous function, it does not matter that a different material is used. Some factors that point to work done to a property being an improvement include whether the work will extend the property's income producing ability or extend the property's expected life or reduce the likelihood of repair bills in the future. Application to your circumstances In your circumstance, the replacement of the power pole is considered works which are described as ‘repairs’ which made good a defect in the pole. The repair is not considered to be an entirety, as it is incapable of providing a useful function without regard to any other part of the premises and is not a separate and distinct item of plant in itself apart from the thing or structure which it serves. Also, replacing the wooden pole with a metal pole is not considered an improvement as the work done merely returns it to the function it provided before the need for the work arose. The replacement of the power pole was done to remedy the safety risk to the property and area. Therefore, the replacement of the power pole is fully deductible. You are entitled to claim a deduction for the costs you incurred under section 25-10 of the ITAA 1997. You incurred expenses to repair the bathroom as a result of water damage from a tenant, you also replaced doors and repaired flooring. The works undertaken were to restore the previous function and were not an improvement. You are entitled to a deduction for these costs under section 25-10 of the ITAA 1997. | Detailed Reasoning - Maintenance Costs: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all outgoings to the extent to which they are incurred in gaining or producing assessable income. However, a deduction is not allowable for outgoings that are of a capital, private or domestic nature. We consider your garden to be an integral part of your rental property which you used for producing income and to be physically, commercially and functionally an inseparable part of your rental property and therefore, a subsidiary part of the rental property rather than an entirety by itself. Therefore, we view the preparation of the ground and the laying of instant turf in your garden of your rental property as restoring what was originally there before the deterioration, damage or defect occurred as a result of neglect by successive tenants. We do not consider the replacement of grass with turf as changing in any form or substance of what was essentially the grass in the garden and do not consider this action as providing a greater efficiency of function to the rental property. Therefore, as you hold the rental property for income purposes during the year ended 30 June 2017, the costs of replacing the grass in the garden is therefore able to be immediately deductible under section 8-1 of the ITAA 1997. You were advised by the fire authority to remove trees from your rental property which were in the vicinity of the dwelling in order to diminish fire risk to your property. Your rental property directly adjacent to a bush reserve and is a bush fire risk area. The cost of the removal is not an improvement and is therefore immediately deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - Capital Works: Section 25-10 of the ITAA 1997 allows a deduction for expenditure on repairs to income producing premises and depreciating assets provided the expenditure is not capital in nature. On the facts provided, it is accepted that the replacement of the cupboards did not result in a significant improvement in the efficiency or function of the kitchen. ATO ID 2003/222 Repairs: replacement of kitchen cupboards in a rental property , outlines the Commissioners view in relation to the replacement of kitchen cupboards. The ATO ID 2003/222 states that; However, if the cupboards are a separately identifiable thing representing an entirety in themselves and the expenditure on replacing the kitchen cupboards results in an improvement or a renewal or reconstruction of an entirety, the expenditure is not a repair but is capital in nature (Taxation Ruling TR 97/23). In Lindsay v Federal Commissioner of Taxation (1961) 106 CLR 377; [1961] HCA 93, the High Court (Kitto J) held that expenditure incurred to renew a slipway was a renewal of an entirety and was not deductible as a repair under section 53 of the Income Tax Assessment Act 1936 (which was rewritten as section 25-10 of the ITAA 1997). This conclusion was drawn on the basis that his Honour considered the slipway to be a separately identifiable capital item, maintaining its own function. Substantially the whole of the old slipway had been demolished and replaced by a new slipway, comprising all new components and was a renewal of a separately identifiable item and not a repair. These principles apply to your situation. The kitchen cupboards are separately identifiable capital items with their own function and are, therefore, an entirety in themselves. Their replacement is a renewal of an entirety and the expenditure is not deductible as a repair under section 25-10 of the ITAA 1997. The expenditure is capital in nature. Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997). In your case, the associated expenses are capital in nature and an immediate deduction cannot be claimed under section 25-10 of the ITAA 1997. However, a deduction is allowable under section 43-10 of the ITAA 1997 at the rate of 2.5%. Generally, when a property is sold, the written down value of the capital asset is be added to the cost base of the property and is used when working out a net capital gain or loss. In your case, the property was purchased prior to 20 September 1985 and is therefore excluded from CGT.