Private ruling: Repairs v capital works
Date of advice: 30 November 2016
Published: April 2017
Ruling period: For the year ended 30 June 20XX. | For the year ended 30 June 20YY.
Date scheme commenced: Year ended 30 June 20XX.

Ruling: Q2: Are you entitled to claim a portion of the cost of rectifying damage caused by a natural disaster to your rental property as a repair? Answer Yes.

Relevant facts and circumstances: You and your spouse each own a percentage of a rental property that was extensively damaged by a natural disaster. The tenant moved out due to no electricity and the damage making the property unliveable. The electricity was restored. Your insurance company assessed the damage and a payment was made. Part of the insurance payment covered for loss of rent for XX weeks. Work to rectify the damage commenced as soon as you had received the insurance proceeds. You believe you have only done repairs and not upgrades to your rental property as a result of the natural disaster damage. You have provided a detailed list of the repairs undertaken. The majority of the work was completed by the time the new tenant moved in.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 25-10 | Income Tax Assessment Act 1997 Division 40 | Income Tax Assessment Act 1997 Section 40-25 | Income Tax Assessment Act 1997 Subsection 40-25(7) | Income Tax Assessment Act 1997 Subsection 40-30(1) | Income Tax Assessment Act 1997 Section 40-755 | Income Tax Assessment Act 1997 Subsection 40-755(3) | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Summary: You are not entitled to a full deduction for the work completed on your rental property. However work such as: ● the repainting of walls ● repairing of floors ● replacing damaged wall panels ● repairing corroded water pipes ● repairing leaking shower taps ● plumbing repairs all restore the efficiency of function, do not provide any substantial improvement, and are considered repairs. The kitchen fixtures including benchtops, cupboards, sinks, tapware and tiles, mains supply box, mirrors fixed to property, plumbing works for refit, window insect screens, bathroom fixtures including baths, toilets, vanity units, tapware and wash basins, shower assets including doors, rods, screens and trays are considered capital expenditure and you are entitled to a deduction for capital works. The removal of asbestos and the lining of the sheds are considered to be an environmental protection activity and the associated costs are deductible. | Detailed Reasoning - Repairs: Section 25-10 of the 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. Taxation Ruling TR 97/23 explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property. The ruling further states that repairs mean the remedying or making good of defects in, damage to, or deterioration of property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. TR 97/23 indicates that expenditure for repairs to property is of a capital nature where: ● the extent of the work carried out represents a renewal or reconstruction of the entirety, or ● the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or ● the work is an initial repair. Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time. TR 97/23 states that with a repair, the work restores the efficiency of function of the property without changing its character. An improvement, on the other hand, provides a greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do. It is acknowledged in TR 97/23 that to repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997. You have incurred expenses for the following work on your rental property in relation to: ● painting costs ● removal of carpet and cleaning damaged floors ● electrical checks ● removal of mould ● cladding (does not appear to be an entirety) ● door handles ● floor polishing plus any items not specifically referred to in the discussions below. These works were not initial repairs or replacements of entireties; nor were they improvements. You have incurred these expenses to restore your property to a rentable state. 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 - Capital works: We consider the following items are capital works: ● Kitchen fixtures including benchtops, cupboards, sinks, tapware and tiles ● mains supply box ● mirrors fixed to property ● plumbing works for refit ● window insect screens ● bathroom fixtures including baths, toilets, vanity units, tapware and washbasins ● shower assets including doors, rods, screens and trays. Division 43 of the ITAA 1997 allows deductions for certain capital expenditure incurred on income producing buildings and other capital works, including alterations, extensions and improvements to buildings. TR 93/23 states that expenditure for repairs is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of an entirety. Paragraph 38 of TR 97/23 states that a 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. The items listed above are capital works for the purposes of Division 43 of the ITAA 1997. The expenditure on these items is capital expenditure for which a deduction is allowable over 40 years at the rate of 2.5% per annum. You are entitled to a capital works deduction for the cost of these items. | Detailed Reasoning - Decline in value: You can deduct an amount equal to the decline in value for an income year of a depreciating asset to the extent that it is used for a taxable purpose (section 40-25 of the ITAA 1997). A taxable purpose includes the purpose of producing assessable income (subsection 40-25(7) of the ITAA 1997), such as rental income. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used (subsection 40-30(1) of the ITAA 1997). Division 40 of the ITAA 1997 does not apply to capital works to the extent that an amount is or could have been deductible under Division 43 of the ITAA 1997. The vertical and roller blinds, vinyl floor coverings, cooktops, dishwashers plus any items not specifically referred to in the discussions above are depreciating assets and a deduction for their decline in value can be claimed. | Detailed Reasoning - Environmental protection activity: You are entitled to claim a deduction for the cost of removing asbestos from your sheds and the lining for the sheds as this is an environmental protection activity. The removal of the asbestos and lining of the sheds will not qualify as a repair as there are no existing defects, damage or deterioration to the shed. The expense is considered to be capital in nature and therefore not deductible under section 25-10 of the ITAA 1997. Section 40-755 of the ITAA 1997 deals with deductions for environmental protection activities. Environmental protection activities are any of the following activities that are carried on by you or for you: (a) preventing, fighting or remedying: (i) pollution resulting, or likely to result, from your earning activity (ii) pollution of or from the site of your earning activity, or (iii) pollution of or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity, (b) treating, cleaning up, removing or storing: (i) waste resulting, or likely to result, from your earning activity (ii) waste that is on or from the site of your earning activity, or (iii) waste that is on or from a site where an entity was carrying on any business that you have acquired and carry on substantially unchanged as your earning activity The term 'your earning activity' is defined in subsection 40-755(3) of the ITAA 1997 to be an activity you carried on, carry on or propose to carry on: (a) for the purpose of producing assessable income for an income year (except a net capital gain) (b) for the purpose of exploration or prospecting (c) for the purpose of mining site rehabilitation, or (d) for purposes that include one or more of those purposes. No deduction is allowable under section 40-755 of the ITAA 1997 for: (a) capital expenditure for constructing a building, structure or structural improvement (b) capital expenditure for constructing an extension, alteration or improvement to a building, structure or structural improvement, or (c) expenditure to the extent that you can deduct an amount for it under another provision of the taxation legislation. You earn assessable income by renting the property. The removal of the asbestos and the lining of the sheds is considered to be an environmental protection activity with the sole or dominant purpose of preventing pollution of the site of your income earning activities by asbestos. Therefore you are entitled to a deduction for the cost of removing the asbestos and the lining of the sheds under section 40-755 of the ITAA 1997. | Detailed Reasoning - Insurance receipt: You received a payment from your insurance company as a result of the natural disaster damage. Whilst we have not ruled on the tax implications of this payment please be aware that all or part of the payment: ● will be assessable where it is a payment for lost rent, ● may be assessable as a recoupment in relation to the repair costs, ● may need to be taken into account when calculating the balancing adjustment for any destroyed depreciating assets. Note: You and your spouse are each eligible for a deduction of a percentage of the allowable deductions as per your ownership interest in the property.

Question 1: Are you entitled to claim the full cost of rectifying damage caused by a natural disaster to your rental property as a repair?