Private ruling: Rental deductions - initial repairs
Date of advice: 2 July 2024
Published: 9 September 2024
Ruling period: Year ended 30 June 20XX
Date scheme commenced: XX XXXX 20XX

Ruling: Q1: Are the expenses incurred as repairs on the taxpayers' rental property deductible under section 25-10 of the Income Tax Assessment Act 1997 ? | A1: No.

Relevant facts and circumstances: This ruling applies to person A and person B (jointly referred to as you). During XXXX, 20XX, you jointly purchased the property. On pre-purchase inspection of the property, you observed uneven walls and door frames, but were unable to investigate further due there being no underfloor access. The carpets were not new, but were clean with no indication of issues, defects or water damage. You advise that the original cottage was constructed around the year 19XX. The original materials in the floor system and framing were: • There were no pad footings or sole plates. • Assorted stacked stone stumps and timber stumps were sitting directly onto the earth. • Piers were formed by stacking bricks on top of each other. • Bearers and joists were hardwood timber.. • Framing was hardwood timber. On XX XXXX 20XX, the property was rented to person C a related family member at market rate. Between 20XX to 20XX, you have stated the property was in an acceptable condition and was functionally efficient. Neither you nor person C identified any defects or need for repairs. During 20XX, person C noticed marks appearing on the carpet in the lounge room of the property. The marks were managed and removed at the time, however continued to emerge as damp patches. Person C advised you that the marks continued to appear, and other areas of the house started to be affected with similar issues of moisture and wet patches. On XX XXXX 20XX, person C and person D signed a rental agreement to remain in the property. On XX XXXX 20XX, locksmiths were called to realign the front door lock, which had sagged. It was noted: that the internal doors were sticking; door frames were more warped; the floor felt uneven, springy, and noisy; and that there was some bulging and deformity to the walls and ceiling. On XX XXXX 20XX, person C vacated the property, on the basis that the rising damp had made the property inhabitable. On XX XXXX 20XX, company A commenced investigations and into the issues identified by you and person C. Company A cut a hole into the floor to access the underfloor section of the property. Company A identified the following defects: • Sub floor space was below street level. • No pad footings or sole plates. • Assorted stacked stone stumps and timber stumps sitting directly onto the earth. • Piers were formed by stacking bricks on top of each other. • Floor extremely uneven throughout the front cottage. • Walls and ceilings uneven throughout. The apportionment for the repairs in the 20XX income year comprised of the following items: • Item 1 - Investigations • Item 2 - Demolition and clearing site • Item 3 - Stabilising posts and beams • Item 4 - Replace room framing - original cottage • Item 5 - Replace footings • Item 6 - Replace floor/doors/framing - original cottage • Item 7 - Replace framing and tie does - original cottage • Item 8 - Flooring and further demolition On XX XXXX 20XX, you paid Company A the amount of $XX for item 1 to be completed. The work included the following: • Progress claim for demolition • Rubbish removal • Chip board, black plastic and asbestos sampling • Labour On XX XXXX 20XX, you paid Company A the amount of $XX for item 2 to be completed. The work included the following: • Materials: LVLs, Tas Oak and Pine Framing, adhesive, galvanised nuts and bolts, brace strap, deformed bars • Labour On XX XXXX 20XX, you paid Company A the amount of $XX for item 3 to be completed. The work included the following: • Materials: Concrete, steel, hire of quick cut saw, survey paint, packers, tape and consumables • Labour On XX XXXX 20XX, you paid Company A the amount of $XX for item 4 to be completed. The work included the following: • Materials: Pine Framing, laminated framing hardwood, bin hire, strapping and consumables • Labour On XX and XX XXXX 20XX, you paid company A the amount of $XX in two instalments for item 5 to be completed. The work included the following: • Materials: LVL's, concrete, concrete pumping, joist hangers, anchors, asbestos testing, Eziper base and adjustable piers, rubbish removal • Labour Between XX XXXX 20XX to XX XXXX 20XX, you paid company A the amount of $XX in three instalments for item 6 to be completed. The work included the following: • Materials: Steel, hardwood, framing pine, doors, cavity sliders, green tongued flooring, tas oak framing, extra LVLs, bags of concrete, flashing tape, sealants, glues, nail fasteners and consumables • Plant Hire of dingo with auger attachments, mobile scaffold, quick cut • Labour On XX XXXX 20XX, you paid company A the amount of $XX for item 8 to be completed. The work included the following: • Materials: Flooring, screws, deformed bars, trench mess, rubbish removal, removal of air conditioner • Labour On XX XXXX 20XX, you paid company A the amount of $XX for item 7 to be completed. The work included the following: • Framing and tiedowns in existing cottage • Labour Due to the extent of the work necessary, you decided to make further improvements to the property. You have stated that with regard to items 1 to 8, the whole item was repaired. The whole of the floor system and internal framing of the original cottage was repaired/replaced. You have stated that there were no modifications or considerable advantages over the old items replaced in the work done for items 1 to 8. You have stated items 1 to 8 were only part of the full renovation and works completed on the property. For the 20XX income year, the total expenditure was $XX. For the 20XX income year, the apportionment you made for repairs was $XX. For the 20XX income year, the apportionment for improvements was $XX. In the 20XX income year, a total expenditure of $XX for spent. No apportionment for repairs were made for the 20XX income year.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 25-10

Reasons for decision: Summary: Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises, or a part of the premises, used solely for income-producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs that are considered capital expenditure. Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10 of the ITTAA 1997. Expenditure to remedy defects, damage or deterioration in existence at the date of acquisition of property (that is, an initial repair) are dealt with in this ruling. Paragraph 4 of TR 97/23 states the expression 'initial repair' refers to a repair by a taxpayer that remedies some defect in property or makes good damage to, or deterioration of, property being a defect, damage or deterioration, which existed when the property was acquired from another person (whether by purchase, lease or licence); and has not arisen from the operations of the taxpayer who incurs the repair expenditure. Paragraph 5 of TR 97/23 goes on to state that a repair is not an 'initial repair' simply because it is the first repair made after property is acquired. It is an 'initial repair' if repair is due when the property is acquired in the sense that the property has defects, damage or deterioration or is not in good order and suitable for use in the way intended. Paragraphs 59 to 61 in TR 97/23 goes on to state why initial repairs are of a capital nature and therefore not deductible. The paragraphs state: 59. Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so whether the property is purchased or obtained under lease or licence by the taxpayer. 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: but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs. 60. 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. 61. 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 (or lease rentals) reflected the need for repairs. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view. 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. | Detailed Reasoning - Application to your circumstances: In XXXX 20XX, you jointly purchased the property. On pre-purchase inspection of the property, you observed: uneven walls and door frames; and that the carpets were not new. At the time of acquisition, there was no indication of issues, defects or water damage on the carpet. You also were not able to investigate further, as there was no underfloor access. You also advised that the original cottage was constructed around the year 19XX. On XX XXXX 20XX, company A commenced investigations and into the issues identified by you and the tenant. Company A cut a hole into the floor to access the underfloor section of the property. They identified the following defects: • Sub floor space was below street level. • No pad footings or sole plates. • Assorted stacked stone stumps and timber stumps sitting directly onto the earth. • Piers were formed by stacking bricks on top of each other. • Floor extremely uneven throughout the front cottage. • Walls and ceilings uneven throughout. The need for repair was not a result of the tenant's occupation of the property. The repairs were initial repairs and the need for repair existed before you purchased the property. It is immaterial whether at the time of acquisition you were aware of the condition of the property, including its need for repair. You are not entitled to an immediate deduction as a repair under section 25-10 of the ITAA 1997. The expenses incurred can be claimed as capital works.