Private ruling: Rental property deductions
Published: February 2014
Ruling period: Year ended 30 June 2014
Date scheme commenced: 1 July 2013

Ruling: Q2: Are you entitled to an immediate deduction for a portion of the expenses of replacing the roof covering and sarking of your rental property? | A1: Yes. | Q3: Will the remaining portion of the expenses be included in the fourth element of the property's cost base? | A2: Yes.

Relevant facts and circumstances: You purchased a house that has been rented out since then. It was in good condition at that time. Building approval for the property was received over thirty years ago. There was an addition built on to the house several years after building was completed. A visual inspection was carried out when you purchased the property which indicated that the condition of roof exterior was below average and would require replacement in due course. Your spouse filed down some of the rust when the exterior of the property was repainted the exterior a few years ago. Approximately 12 months ago the tenants complained of mould on the ceiling. The real estate agent said that it was caused by the roof. You had a tradesman have a look and they said that the roof covering needed to be repaired. The roof covering of the house was made of product B when you purchased it. You have just had it replaced with a product C roof covering. Product C was not compatible with product B as it causes a reaction. As the patterns on each type of roof covering would not match it would not be possible to make the roof covering leak proof. No alteration to the design of the roof was made. When the roof covering was taken off the sarking was damaged so it was replaced as well. This was included in the total cost of the job.

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

Reasons for decision: Detailed Reasoning - Rental property deductions: As you are aware 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, no deduction is allowable where the expenditure is of a capital nature. You have also referred to Taxation Ruling TR 97/23 Income tax: deductions for repairs , which provides the Commissioner's view on the deductibility of repairs. The ruling points out that a 'repair' involves a restoration of a thing to a condition and efficiency it formerly had without changing its character. Works can be fairly described as repairs if they are done to make good damage or deterioration of property that has occurred by ordinary wear and tear, by accidental or deliberate damage, or by the operation of natural causes during the passage of time. The replacement of the roof covering of your rental property due to deterioration is a repair that you carried out to restore its efficiency and function and did not change the character of the property. It is therefore correctly characterised as a repair. Expenses incurred in relation to the repair will be immediately deductible under section 25-10 unless they are incurred in remedying defects, damage or deterioration that was in existence at the date of acquisition. Under such circumstances the repairs are referred to as 'initial repairs' which are capital in nature and not deductible under section 25-10. | Detailed Reasoning - Initial repair: Expenditure for repairs is fully deductible only if it involves the remedying of defects, damage or deterioration wholly attributable to the period in which the property is held by you for income producing purposes. Where expenditure remedies such conditions to the property which existed at the time of purchase and did not arise from the income producing activity, the expenditure is capital in nature. When you purchased the property you had an inspection carried out. The report stated that the condition of the roof exterior was 'below average' and that the roof covering condition was 'fair/poor'. In addition, the report stated the metal roofing was rusting and required treatment to limit further deterioration, and would require replacement in due course. It is apparent that defects and deterioration of the roof covering existed at the time of purchase which have continued to exist and worsen during your period of ownership. When your tenants recently reported mould on the ceiling you had a tradesman examine the roof covering which lead to its subsequent replacement. To this end the replacement of the roof covering is an initial repair. TR 97/23, at paragraph 59, confirms that expenditure incurred on initial repairs is capital expenditure and is, therefore, not deductible under section 25-10 of the ITAA 1997. This paragraph also states that the cost of effecting initial repairs is still not allowable even if some income has been earned before the repair expenditure is incurred. In other words, the character of initial repairs is not altered because income is derived from the property before the expenses are incurred on the initial repairs. | Detailed Reasoning - Initial repair costs can be dissected or apportioned: Paragraph 63 of TR 97/23 explains that an initial repair expense can be dissected or apportioned to allow a deduction under section 25-10 of any part of the expense that remedies deterioration arising from the holding of the property for income purposes after it was acquired. The Commissioner's view is that dissection or apportionment on a time basis is appropriate if repair costs are incurred either due to defects (whether expected or unexpected) that arise gradually over an extended period or due to wear and tear or deterioration that occurs: a) in part before the property was acquired; and b) in part in the course of your holding of the property for income purposes. This dissection may be done in the year in which the expenditure is incurred. Therefore the apportionment needs to be over the age of the building and the length of time that you have been using it for income producing purposes. As an example if the property was built 20 years ago, the cost of the repairs needs to be apportioned over the 20 years. You are able to claim the cost of the apportionment for the amount of time that you have held the property for income producing purposes. The balance of the repair expenditure incurred, being of a capital nature, can be included in the property's cost base for your capital gains calculation when you sell the property in the future as per Taxation Determination TD 98/ 19 Income tax: capital gains: may initial repair expenditure incurred after the acquisition of a CGT asset be included in the relevant cost base of the asset? This cost can be included in the fourth element of your cost base.