Private ruling: Rental property expenses - replacement of asbestos cladding
Date of advice: 16 August 2016
Published: September 2016
Ruling period: Year ending 30 June 2017 | Year ending 30 June 2018
Date scheme commenced: 1 July 2016

Ruling: Q1: Are you entitled to a deduction for the income-producing use of your property in relation to the removal and replacement of asbestos cladding and painting of the new cladding? | A1: Yes

Relevant facts and circumstances: You purchased a property in the 1990s. You own this property outright. You rent this property out as a holiday home and also use it for private purposes on occasion. The property is clad with asbestos impregnated fibre cement (asbestos cladding). The works You plan to undertake work to replace the asbestos cladding as it is weathered and you are concerned about the ongoing health risks to your tenants from occupying the house due to the risk of airborne asbestos fibres which can be released from the weathered external asbestos cladding and internally when tenants accidentally crack or puncture the walls. After removal of the asbestos cladding you will install modern equivalent materials. The property would then be repainted. There will be no structural changes made to the property. Condition of the cladding The roof is weathered and many of the steel screws that secure the asbestos cladding are badly rusted. You advise that it would be difficult to replace these screws safely without disturbing the asbestos cladding. The asbestos cladding on the external walls has been compromised by weathering and severe rusting of many of the clout nails that secure the panels. You advise that you cannot replace these nails safely without disturbing the asbestos cladding. The internal asbestos cladding on the walls and ceilings are generally in fair condition however you have been advised by a building contractor that any work to replace the external walls and roof would potentially release asbestos into the roof cavity and wall frames. The contractor has therefore recommended that you replace the internal walls and ceilings at the same time.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 25-10. | Income Tax Assessment Act 1997 Section 40-755. | Income Tax Assessment Act 1997 Section 40-760.

Reasons for decision: Detailed Reasoning - Deduction for 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. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature. The word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. Taxation Ruling TR 97/23 Income Tax: deductions for repairs states that the word 'repair' 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. Further, work done to property in controlling health risks associated with the use of dangerous substances such as asbestos does not qualify as a 'repair' for the purposes of 25-10 unless the work remedies or makes good defects in, damage to or deterioration (in a mechanical or physical sense) of, the property. What is a 'repair' for the purposes of section 25-10 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. If work done to the property goes beyond what is a 'repair' in terms of section 25-10, any expenditure for the work is not deductible. On the facts provided, it is the Commissioner's view that the asbestos cladding is not defective, damaged, or deteriorated to a sufficient extent and a deduction is not available for the expenditure on its removal and replacement. | Detailed Reasoning - Capital works expenditure: Division 43 of the ITAA 1997 allows a deduction for certain capital works. The removal of the asbestos cladding and replacement with modern equivalent materials is not capital works expenditure. The work does not constitute structural improvements, or extensions, alterations or improvements to structural improvements. The change to cladding is not an alteration which changes the character or efficient function of the cladding. | Detailed Reasoning - Deduction for environmental protections activities: Although the Commissioner does not consider the works to be a 'repair' for the purposes of 25-10 of the ITAA 1997, you may be entitled to a deduction for expenditure on environmental protection activities pursuant to section 40-755 of the ITAA 1997 on the basis that: a) the expenditure is in respect of environmental protection activities; b) the environmental protection activity is connected to your earning activity; and c) the sole or dominant purpose is the carrying on of those environmental protection activities. Section 40-760 of the ITAA 1997 provides no deduction is allowable where the works constitute: 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, as in, the environmental protection provisions are provisions of last resort. Paragraph 27 of TR 97/23 states: An example of expenditure that is not deductible as a repair is the cost of removing asbestos insulation from factory walls (if the insulation is not in need of repair) and replacing it with modern insulation material. This work does not constitute the rectification of a defect in a mechanical or physical sense as envisaged by section 25-10. The asbestos insulation functions efficiently as insulation. It is being replaced because of the health risk it might pose to factory occupants, not to 'repair' the factory in the ordinary sense of the word. The costs, if incurred on or after 19 August 1992, are deductible under subsection 82BK(1) of the ITAA 1936 as allowable environmental protection expenditure. Example 2 in paragraph 163 of TR 97/23 expands on paragraph 27 and states: By January 1997, Widgets Pty Ltd has used a building for a manufacturing plant for many years. Widgets Pty Ltd discovers on testing for contaminants that insulation in the roof and walls contains dangerous levels of asbestos fibres. The contaminated insulation had been placed in the building by the previous owner. The company immediately set about removing the insulation and replacing it with a safe alternative. Expenditure incurred by Widgets Pty Ltd in removing and replacing the insulation is not a 'repair' and not deductible under section 25-10. However, because the expenditure is incurred entirely for an environment protection activity, namely, removing pollution from a site on which the company carries on its income producing activities (subparagraph 82BM(1)(a)(ii) of the ITAA 1936), it is deductible under subsection 82BK(1) of that Act. The expenditure is not in respect of constructing an improvement to the building so subsection 82BN(1) of that Act does not preclude a deduction under the environment protection provisions. Subsection 82BK(1) of the ITAA 1936 has since been replaced by section 40-755 of the ITAA 1997 but it is clear from paragraphs 27 and 163 of TR 97/23 that actions undertaken in respect of the removal of asbestos will be the preventing, fighting or remedying of pollution and as such, fall within the definition of an environment protection activity. You are primarily concerned about the effects the asbestos cladding may have on your tenants and as such, the dominant purpose of carrying out the works is to prevent, fight or remedy pollution resulting from your rental income producing activity at the property. Further, the removal and replacement of the cladding does not constitute capital expenditure that is excluded from being deductible under section 40-760 of the ITAA 1997. It is therefore the view of the Commissioner that expenditure incurred in the removal, replacement and painting of the asbestos cladding at the property is deductible under the environmental protection activities provisions. As the property is held in the year of income partly for income purposes and partly for non-income purposes, the amount of expenditure allowable as a deduction is to be calculated by reference to the extent to which the property was held in the year of income for income purposes.