Private ruling: Rental property expenses
Published: November 2011
Ruling period: Year ended 30 June 2011
Date scheme commenced: 1 July 2010

Ruling: Q1: Are you entitled to a deduction for repairs to your rental property? | A1: Yes | Q2: Are you entitled to a capital works deduction for improvements to your rental property? | A2: Yes

Relevant facts and circumstances: You own a property which was rented out for a number of years. The shower floor in the property was leaking and you incurred costs to repair water-damaged floors in the bathroom and an adjoining room. You incurred costs to waterproof and re-tile the bathroom. The shower area had been previously waterproofed. The remainder of the bathroom had not been waterproofed. You had the tiled area in the bathroom waterproofed and re-tiled. You had a new shower screen door fitted to replace a shower curtain and replaced a shower rose. The works were carried out in 2010 and invoiced later in 2010 The tradesman carrying out the waterproofing work advised you that the bathroom had to be waterproofed to comply with local council regulations.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 25-10 | Income Tax Assessment Act 1997 Division 43 | Income Tax Assessment Act 1997 Section 43-25

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 held for income producing purposes, provided the repairs are not of a capital nature. Taxation Ruling 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 · the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair' · the work is an initial repair. TR 97/23 provides that, as the word 'repair' is not defined within the tax legislation, it takes its ordinary meaning. Generally, a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. Works can fairly be described as 'repairs' if they are done to make good damage or deterioration 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. To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement may be done to property and still be a repair. If the work amounts to a substantial improvement it is not a repair and is not deductible under section 25-10 because it is work of a capital nature. 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. If work done goes beyond 'repair' and the whole cost is capital expenditure, no amount is allowable as a deduction under section 25-10 for 'notional' repairs, that is, an amount it is estimated that repair work would have cost if the property had in fact merely been repaired. If repair work is inextricably bound up with work of an improvement nature, and the cost of the repair work cannot be separated from the cost of the improvements, then the cost of the entire work is regarded as being of a capital nature and not deductible. An 'entirety' is defined as something separately identifiable as a principal item of capital equipment. Furthermore, a reconstruction of a whole property is not a deductible repair. Where there is a replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, it is an improvement. To constitute a 'repair' for the purposes of section 25-10, work done to meet requirements of regulatory bodies must satisfy the general principles of what constitutes a repair. Work done to repair property that also happens to meet the requirements of regulatory bodies is deductible under the section. However, work done solely to meet requirements of regulatory bodies is not a 'repair' for the purposes of the section. Expenditure on work that modifies property to satisfy regulatory requirements is allowable under section 25-10 as repair expenditure only if the work: · remedies or makes good a defect in, damage to, or deterioration (in a mechanical or physical sense) of, property · restores the efficiency of function of the property · does not produce a new and different function for the property nor add to the property a function that it did not previously have. The expenditure must not be of a capital nature, for example, an improvement. In your case the entire bathroom was waterproofed as required by council regulations. However, this does not mean that the waterproofing work constituted a deductible repair. The shower area of the bathroom had been previously waterproofed and the shower was leaking which caused damage to the bathroom and other parts of the house. It is accepted that the work undertaken to restore the area to its former condition and to remedy the damage caused by the leaking shower area would be a deductible repair. This would include the cost of replacing the shower rose unless the replacement constituted an improvement. However the costs for the additional work undertaken to waterproof the rest of the bathroom would be considered to be an improvement and would not be a deductible repair. The shower screen which replaced a shower curtain would also be considered to be an improvement and as such is a capital item for which an immediate deduction is not available. You are able to claim a deduction for the repairs to the extent that you can separate the cost of the repair work from the cost of the improvement. If the cost of the repair work cannot be separated from the cost of the entire job, the work will be considered a capital improvement and not deductible under section 25-10. | Detailed Reasoning - Capital works deduction: Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997) provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5% of construction expenditure. In your case, a portion of the works done to the bathroom of your rental property is considered to be an improvement to the building. You are therefore entitled to a deduction for this expenditure at a rate of 2.5% of construction expenditure.

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