Private ruling: Deduction for rental property repairs
Date of advice: 23 May 2017
Published: September 2017
Ruling period: Year ending 30 June 2016
Date scheme commenced: 1 July 2015

Ruling: Q1: Are you entitled to claim a deduction a deduction for the costs incurred in repairing the damage done to your rental property? | A1: Yes. | Q2: Are you entitled to a deduction for the interest payable on the loan you took out to pay for the repairs? | A2: Yes.

Relevant facts and circumstances: You and your spouse have an investment property. You own the property as joint tenants; 50% ownership each. You have rented the property out for several years. One of the tenants caused a great deal of intentional damage. However, the insurance on the property would not cover the majority of the damage unless you reported a crime to the police. However, you decided not to do this for personal reasons. Due to excessive delays in restoring the house to a habitable condition, you and your spouse moved into the property temporarily so you could rent out your primary residence in order to maintain your level of income. The repairs involved: ● The complete kitchen. No changes were made to the kitchen design or layout, just replacement of damaged fixtures and fittings and the retiling of the kitchen dining area. ● In repairing the bathroom you had to remove a bath shower. The water spout had been stood on, damaging an inside wall, resulting in a constant wet patch in the adjoining bedroom. The repair necessitated removal of tiles, for which you could not find replacement tiles which matched the existing ones. The layout of the bathroom remained unchanged from its pre-repaired state. ● Repairs to the laundry cupboards and sink unit. ● All X internal doors in the passage, replacement of rear sliding door (which was unsound and not lockable) and the front door. ● The ceiling in one bedroom. You have provided a detailed breakup of the items repaired or replaced and the costs incurred. You and your spouse incurred the expenses. You had to re-mortgage the property with a $X loan to pay for the repairs. You did not use the borrowed money for any other purpose. You incur interest on the loan. Your insurance paid $X of the total claim of $X. The amount each of you wishes to claim as a deduction is calculated as follows: Total expenses for the repairs was: $X The insurance paid you: $X Leaving you to pay net expenses of: $X The deduction each of you will claim: $X All the work done related to the repairs, that is, no other work was done except the repairs. You hired a bobcat which was used to clear the site of all demolition materials. You contracted tradesmen to do the repairs. You have all the receipts for the repair expenses incurred as well as written and photographic evidence from the insurance company and contractors.

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 40-25 | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Detailed Reasoning - Repairs: You are entitled to a deduction for the cost of repairs to premises used for income producing purposes providing the expenditure is not of a capital nature (section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)). The word repair is not defined within the tax legislation and takes its ordinary meaning. Repair involves a restoration of a thing to a condition it formerly had without changing its character ( W Thomas and Co Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710). Expenditure for repairs is of a capital nature where: ● the work is an initial repair ● the extent of the work carried out represents a renewal or construction of the entirety, or ● the work results in a greater efficiency of function, therefore representing an improvement rather than a repair. Expenditure incurred to remedy defects, damage or deterioration in existence at the date of acquisition of property is an initial repair. 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 entirety is defined as something separately identifiable as a principal item of capital equipment ( Lindsay v. FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201). 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. 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. 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. In your case, the following works are considered repairs: ● The complete kitchen. No changes were made to the kitchen design or layout, just replacement of damaged fixtures and fittings and the retiling of the kitchen dining area. ● In repairing the bathroom you had to remove a bath shower. The water spout had been stood on, damaging an inside wall, resulting in a constant wet patch in the adjoining bedroom. The repair necessitated removal of tiles, for which you could not find replacement tiles which matched the existing ones. The layout of the bathroom remained unchanged from its pre-repaired state. ● Repairs to the laundry cupboards and sink unit. ● All X internal doors in the passage, replacement of rear sliding door (which was unsound and not lockable) and the front door. ● The ceiling in one bedroom. These works were not initial repairs or replacements of entireties; nor were they improvements. The works simply restored the property to its original condition without changing its character. As such, you are entitled to a repairs deduction under section 25-10 of the ITAA 1997 for the cost of these works. | Detailed Reasoning - Application to your situation: As you own the property as joint tenants, you are each treated as owning an equal interest in the property; or 50/50 ownership. Therefore, you are each entitled to claim a deduction of 50% each of the net cost of the repairs after deducting the amount you received from insurance. | Detailed Reasoning - Interest on loan: Section 8-1 of the Income Tax Assessment Act 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. Whether interest has been incurred in the course of producing assessable income generally depends on the use to which the borrowed funds have been put. Where a borrowing is used to acquire an income producing asset or relates to an income producing activity, the interest on this borrowing is considered to be incurred in the course of producing assessable income. It is accepted the other expenses incurred in respect of the rental property, such as repairs, are also deductible. In your situation, you have incurred interest expenses on the loan which was used to pay for repairs to your rental property. The damage was done while you were deriving assessable income from the property. It is accepted that this interest is in respect of the production of your assessable income and accordingly you are entitled to a deduction for the interest you incur on your loan. | Detailed Reasoning - Application to your situation: As you own the property as joint tenants, you are each treated as owning an equal interest in the property or 50/50 ownership. Therefore, you are each entitled to claim 50% of the interest expenses of the loan you obtained to pay for the repairs. | Detailed Reasoning - Other information - document retention: You should retain your documentary evidence for two years from the date of the completion of the repairs.