Private ruling: Rental repair deduction
Date of advice: 29 November 2016
Published: April 2017
Ruling period: Year ending 30 June 20ZZ
Date scheme commenced: 1 July 20YY

Ruling: Q1: Are you entitled to a deduction for the levy charged by the body corporate to cover the cost of building repairs and maintenance as a repair? | A1: No. | Q2: Can you include the special levy in the cost base of the rental property? | A2: Yes.

Relevant facts and circumstances: You purchased a property in 20XX with a settlement date in 20YY. You share ownership of this property 50/50 with your spouse. You began renting the property in 20YY as an investment property. You attended an General Meeting (GM) of the owners' corporation in 20YY where it was decided that repair and maintenance works were required to the building to bring the building back to its original condition and architecture. A quote was provided of $XYZ to complete these works. The owners corporation motioned and it was passed that this cost would be divided between apartment owners as a special levy. Your share of the cost was an amount charged as a special levy. You have provided a detailed inventory of the repairs that are required to the building.

Relevant legislative provisions: Strata Schemes Management Act 1996 (NSW) | Income Tax Assessment Act 1997 Section 25-10 | Income Tax Assessment Act 1997 Section 110-25(5)

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 used for income producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature. Taxation Ruling TR 97/23 which explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction. The term 'repair' means the remedying or making good of defects in, damage to, or deterioration of property as long as the restoration is of the entirety and does not change the character of the property. The cost of repairing an income producing property is deductible. However, TR 97/23 states that expenditure to remedy defects, damage or deterioration in existence at the date of acquisition is constituted as initial repairs and no deduction is allowable. 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. In your case, you acquired the property in 20XX. The deterioration of the building which resulted in the repairs would have occurred over a period of time and not just since you purchased the rental property. Thus the Commissioner considers the damage was present at the time the property was acquired. Therefore these repairs would constitute as an initial repair and are not deductable as initial repairs are capital in nature. | Detailed Reasoning - Cost base: The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset. The cost base of a CGT asset is made up of five elements. You need to add together all these elements to work out your cost base for each CGT asset. In your case, the levy that you have incurred can be included in the fourth element being a capital cost to preserve the value of your asset as per section 110-25(5) of the ITAA. It will be taken into account when calculating the capital gain or loss on the property when you dispose of it in the future.