Private ruling: Rental property expenses - interest deduction and repair or improvement
Date of advice: 10 June 2021
Published: August 2021
Ruling period: Year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q3: Is the cost of replacing a retaining wall located on your rental property an allowable deduction as a repair? No.

Relevant facts and circumstances: You and your spouse are residents of Australia for taxation purposes. You and your spouse purchased the rental property in the early 2010's. You and your spouse took out a bank loan to pay for the rental property. The property was immediately advertised for rent after you purchased it and was rented to a third party. The property was never used for private use. The property was rented to tenants in XXXX who were subsequently evicted in 20XX for not paying rent. You were able to tenant the property again. The tenant gave notice to vacate the property in XXXX and left the property on XXXX. You received the last lot of rental income in XXXX. Damage occurred to part of a timber retaining wall at the property during a storm. Your insurance did not cover this damage. You repaired the retaining wall at the rental property in XXX. It was more economical to replace the whole wall rather than part of it. You replaced it using the same material as the old wall timber. At the same time as rectification of the retaining wall, minor sundry repairs and maintenance were undertaken on the internal aspect of the property. These included repairing internal doors, replacing a safety switch, and replacing a worn carpet. Having experienced difficulties with the previous tenants and in view of the mental and financial impact of losing a tenant and having to replace a retaining wall with no income from the property in that period, the decision was made not to market the property for rent again but to sell it. Having consulted with your real estate agent the view was taken that it would be difficult to sell the property or to achieve a realistic price if the retaining wall was not dealt with prior to sale. This decision was made in XXXXX. The property was marketed for sale in XXXX. An offer was received and contracts for sale were exchanged on XXXX with settlement taking place on XX XXX. The loan was paid out in full after the property was sold.

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

Reasons for decision: Summary: An expense is deductible under section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if and to the extent to which it is incurred in gaining or producing your assessable income or in carrying on a business for that purpose. However, you cannot claim a deduction for an expense that is of a capital, private or domestic nature. A deduction is only allowable if an expense: • is actually incurred • meets the deductibility tests • Satisfies the substantiation rules. Where the property is held for the purpose of producing assessable income, a taxpayer is entitled to deductions for expenses incurred. Some expenses are deductible in the year they are incurred (under sections 8-1, or 25-10 of the ITAA 1997 while others are deductible over a number of income years (under divisions 40 and 43 of the ITAA 1997). The purpose of the loan did not change when you decided to stop renting the property out. This position is in line with Taxation Ruling 2004/4 Income tax: deductions for interest incurred prior to commencement of, or following the cessation of, relevant income earning activities . The interest you incurred on the property for the period it was not rented after XXXX are allowable deductions. | Detailed Reasoning - Repairs: Section 25-10 of the ITAA 1997 generally allows a deduction for expenditure incurred on repairs to premises or plant held or used by a taxpayer for the purpose of producing assessable income. However, capital expenditure is not deductible under section 25-10. Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23)explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10. TR 97/23 states that in its context in section 25-10, the word '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. Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Expenditure incurred for repairs is not deductible under section 25-10 if the expenditure is of a capital nature. TR 97/23 states that expenditure for repairs to property is capital expenditure if the expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety. The term 'entirety' is used by the courts in repair cases to refer to 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). In Lindsay's case , the taxpayer company was a slip proprietor and ship repairer. It claimed a deduction for the cost of reconstructing one of two slipways. In finding that the work was not repairs, Kitto J rejected the taxpayer's submission that either the whole slip (comprising the slipway, hauling machines, cradles and winches by which vessels were manoeuvred on to it) or the whole of the business premises containing the slipway should be regarded as the relevant entirety. His Honour decided that the slipway was an entirety by itself and not a subsidiary part of a larger whole. Property is more likely to be an entirety, as distinct from a subsidiary part, if (TR 97/23): • 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. TR 97/23 states that a reconstruction of the whole of property (for example, fencing or a railway) is not a deductible repair. The ruling states: "Replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement." The issue of repairs to retaining walls has been considered in a number of cases, including Case S13 , 85 ATC 171 and Mt Isa Mines Ltd v FC of T 90 ATC 4267. In Case S13 , two retaining walls built on a rental property to prevent soil erosion were each held to be an 'entirety'. The replacement following storm damage, with two new retaining walls which were higher, stronger and of different material, was held to be an improvement to a fixed capital asset and not repairs. In Mt Isa Mines Ltd v Federal Commissioner of Taxation , a mining company constructed a retaining wall to create a tailings dam on a mine site. The retaining wall was intended to be the first stage of a much larger development. Following seepage through the retaining wall a new retaining wall, or embankment, was constructed with the result that the old retaining wall was submerged. The Federal Court held that the expenditure incurred in building the new retaining wall was not deductible because it was an outgoing of capital or of a capital nature and did not constitute repairs to the old retaining wall or to the dam. In your case, the minor sundry repairs are an allowable deduction. Your expenditure on replacing the retaining wall is not a deductible repair under section 25-10 ITAA 1997 because the whole retaining wall was replaced, making it a reconstruction of the entirety. The cost of replacing an entire retaining wall with a new retaining wall is of a capital nature.

Question 1: Are you entitled to a deduction for interest on a loan taken out on a rental property? | Question 2: Are the minor sundry repairs an allowable deduction? | This ruling applies for the following period periods :