Private ruling: Repairs and maintenance rental deduction
Date of advice: 15 June 2016
Published: August 2016
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Can a repairs and maintenance deduction be claimed for a special levy imposed by the strata body for repairs to the property for concrete works to parts of the property in which you own a unit? | A1: Yes | Q2: Can a repairs and maintenance deduction be claimed for a special levy imposed by the strata body for works to the property, property in which you own a unit, to complete an upgrade as per a, authority order? | A2: No

Relevant facts and circumstances: You own a strata titled property and aside from a short period where you lived in the property have rented it since purchase. The property has been affected by a concrete problem which has required major remedial works to be carried out. You advised at the time of purchase the building was in good order and there was no evidence of a concrete problem. You did not obtain a separate building inspection prior to the purchase of the property. Your solicitor reviewed the minutes of meetings of the owner's strata available at the time and found nothing out of the ordinary. At a point of time in your ownership a consultant completed an assessment of the actual and expected sinking fund requirements as required by the Strata Schemes Management Act 1996 . The budget to be adopted for the sinking fund was a usual amount and did not involve any additional expected costs. A short time later, quotes were obtained for an inspection by engineers for remedial works to the building. At a meeting of the strata body a representative of the consulting firm advised that some balconies should be core drilled to ascertain the depth of the a concrete problem in the balcony slabs to allow an accurate quotation to be obtained from tenders. This was the first time that the damage or remediation works required had been referred to a concrete problem in the minutes of meetings of the strata body. A period of time later quotes had been obtained for remedial works required to repair the damage caused by a concrete problem. A report for the works to be completed was provided by an engineering firm. From this there was a tender process and quotes were obtained for the remedial works and a company engaged to do the works. The engineer's report says the building is approximately XX years old. At an extraordinary general meeting of owners it was resolved to raise a special levy for remedial works, with the levy being payable as a lump sum by owners. The works included but were not limited to repairing the concrete damage and implementing a corrosion protection system, new tiles and handrails, complete membranes and painting, fire hydrant upgrade and new garage doors. The engineer's report stated that generally the building and the slabs were in reasonable condition, considering the age and location of the building. The degree of spalling concrete damage varied throughout the units. In relation to the main balcony slabs of units, your unit was in the lowest priority category. You advised the costs relating to garage upgrades to the doors and motors would be charged to the owners of the garages. Your unit does not include a garage. You advised that the upgrade to the fire hydrant/doors was a separate project in response to an order from the council.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 section 25-10 | Income Tax Assessment Act 1997 section 43-10

Reasons for decision: Detailed Reasoning - Special Levy: The body corporate of your rental property complex has levied a special contribution to fund repairs to the common area of the complex. The character of an expense follows the purpose for which the expense was incurred. It follows that if the levy is used to fund expenditure which would be deductible then the contribution made is also deductible. To determine if your special levy contribution is deductible, we first need to look at what the levy monies will be expended upon and the deductibility of those expenses. You have advised the levy was used by the body corporate to undertake remedial work as noted in the engineer's report and in the tender document. | Detailed Reasoning - Meaning of repairs and maintenance: Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. However there are also provisions in the income tax law which deal with specific deductions, including repairs and capital works (section 25-10 and Division 43 of the ITAA 1997). Section 25-10 of the ITAA 1997 states that expenditure incurred by you for repairs to any premises, or part of premises, plant, machinery, tools or articles held or used by you solely for the purpose of producing assessable income is an allowable deduction. However, a deduction is not allowable if the expenditure is of a capital nature, for example, an improvement. The term 'repairs' is not defined in section 25-10 of the ITAA 1997. Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) provides the Tax Office's view on expenditure that is allowable under section 25-10 of the ITAA 1997. Paragraph 13 of Taxation Ruling TR 97/23 states the following: The word 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property. Paragraph 15 says that: A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Works can be fairly 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 (whether expected or unexpected) during the passage of time. 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. Consequently, what is considered to be a repair for the purposes of section 25-10 is determined by the facts of each case. | Detailed Reasoning - Replacement of a subsidiary part or an entirety: Determining what is the entirety is a question of fact in each case. According to TR 97/23, property is more likely to be an entirety if: (a) the property is separately identifiable as a principal item of capital equipment; or (b) 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 (c) the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or (d) the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law (paragraph 38 of TR 97/23). Property is more likely to be a subsidiary part rather than an entirety if: (a) it is an integral part of some larger item of plant; or (b) the property is physically, commercially and functionally an inseparable part of something else (paragraph 39 of TR 97/23). In your case the works done to the building would not be considered an entirety, as individual parts of the building are not capable of providing a useful function separate from the rental unit itself. | Detailed Reasoning - Improvement v repair: The distinction between an improvement and a repair is discussed at paragraphs 44 to 54 and 120 to 124 of TR 97/23. In regards to the use of different material, the Commissioner accepts that the use of a different material does not necessarily prevent the work from being a repair, provided the work merely restores a previous function to the property or restores the efficiency of the previous function. Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. It is restoration of a thing's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant. Substantial improvements, additions, alterations and modernisations are not repairs. Some of the factors pointing to an improvement rather than a repair are whether: the modification work has effected an improvement to the asset; there is greater efficiency of function of the property; there is an increase in the value of the asset; and the expenditure reduces the likelihood of future repairs. In your case works performed to reseal, repaint and retile were completed to rectify existing deterioration and to prevent further deterioration and therefore constitutes a repair. The remaining remedial work carried out on the unit complex containing your rental property would not be considered an improvement as it was simply done to restore the property's normal function. | Detailed Reasoning - Initial repair: If an asset was in disrepair at the time of its acquisition, the cost of initial repairs to remedy those defects is of a capital nature and non-deductible because it would have be taken into account in the purchase price. 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. 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 reflected the need for repairs. 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 of the ITAA 97. In your case, the remedial work carried out on the unit complex containing your rental property needed to be done due to wear and tear sustained over a period of time. At the time you acquired the property there was no evidence of a concrete problem. You advised the building was in good order. The concrete problem or signs of a concrete problem had not been raised as an issue in the minute of meetings of the strata body prior to your purchase. Therefore the works are not considered to be initial repairs. | Detailed Reasoning - Work done solely to meet requirements of regulatory bodies: To constitute a repair for the purposes of section 25-10 of the ITAA 1997, work done to meet requirements of regulatory bodies must satisfy the general principles. 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. If government regulations require something to be added to property (e.g. an automatic sprinkler system to a building or an air bag to a motor vehicle), work done to comply with this requirement does not constitute a repair because it is not work done to remedy or make good any defect, damage or deterioration in a mechanical or physical sense. In any event, this is likely to involve capital expenditure and be excluded from section 25-10 of the ITAA 1997. From the information provided the work undertaken to complete the upgrade works appears to be as a result of an order from the council. As noted previously where work is completed solely to meet requirements of regulatory bodies it is not a repair for the purposes of the section 25-10 of the ITAA 1997. The expenditure is of a capital nature as it is not work done to remedy or make good any physical or mechanical defect, damage or deterioration of property. A deduction is not allowable under section 25-10 of the ITAA 1997. An immediate deduction is not allowed for any portion of the special levy that is raised specifically for improvements/capital works. For example the portion of the levy that was raised to meet the fire order requirements as included in the quote from the company completing the remedial works is considered to be an improvement as the work will be new to the building and not a repair. However, you may qualify for a capital works deduction under Division 43 of the ITAA 1997 for these items. | Detailed Reasoning - Capital works: Under Division 43 of the ITAA 1997 a taxpayer can claim a deduction for capital expenditure incurred in constructing capital works, including buildings and structural improvements. Under section 43-10 of the ITAA 1997, a taxpayer can claim a deduction for capital expenditure incurred in constructing capital works, including buildings and structural improvements. The deduction is either 2.5% or 4% of the construction expenditure, depending on when construction started and how the capital works are used. In the case of residential rental properties, a taxpayer can deduct certain kinds of construction expenditure and the deduction is generally spread over a period of 25 or 40 years. A deduction is only available for the number of days that a property is rented, or available for rent, in any income year from the date that the works are completed. In your case, your share of the cost of the work undertaken for the portion of the levy that was raised to meet the fire order requirements is an allowable deduction under the capital works provisions.