Private ruling: Rental property
Published: June 2012
Ruling period: Year ending 30 June 2012
Date scheme commenced: 1 July 2011

Ruling: Q1: Are you entitled to claim the entire cost of work performed on the waste water management system in your rental property as a deduction in the year ended 30 June 2012? | A1: No. | Q2: Are you entitled to claim a portion of the cost of work performed on the waste water management system in your rental property as a deduction in the year ended 30 June 2012? | A2: Yes.

Relevant facts and circumstances: You own a rental property. Your tenants complained of severe odours and effluent seepage on the property grounds. An engineering geologist examined the property and provided a solution to the problem. To remedy the problem, you engaged a plumber to: · pump out and remove the existing single purpose fibreglass septic tank which had collected blackwater · install a new dual purpose septic tank to service both greywater and blackwater · remove the grease trap from the kitchen waste and connect kitchen waste and the greywater line to the new septic tank · install new drainage from the septic tank to a new distribution box · provide new absorption trenches · install spouting to carport and provide drainage to existing water tank, and · provide overflow from existing water tank to street.

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

Reasons for decision: Summary: You are not entitled to a deduction for the entire cost of the work performed on the waste water management system of your rental property as the work is considered to be a structural improvement. You are, however, entitled to claim a capital works deduction with regards to the work performed. | Detailed Reasoning - Detailed reasoning: Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to a property which is used solely to produce assessable income. However, subsection 25-10(3) of the ITAA 1997 denies a deduction for repairs where the expenditure is of a capital nature Taxation Ruling TR 97/23 provides guidelines on the deductibility of repairs. Generally, 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. Paragraph 16 of TR 97/23 explains that to repair property improves to some extent the condition it was in immediately before the repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997. While a repair restores the efficiency of the function of a property without changing its character, an improvement goes beyond this and provides a greater efficiency of function in the property. An improvement usually brings the property into a more valuable or desirable form or condition than a repair would and generally changes the character of the property. Where the extent of the work carried out represents a renewal or reconstruction of an entirety, rather than a replacement of subsidiary parts of a whole, the expenditure will be capital in nature and not deductible under section 25-10 of the ITAA 1997. An entirety is defined as something separately identifiable as a principal item of capital equipment ( Lindsay v. FC of T (1961) 106 CLR 377). TR 97/23 provides that in circumstances where repairs are carried out at the same time as improvements, and it is possible to identify and quantify those parts of the work that constitute repairs, the cost of the repair work will be deductible. In your case, the work performed on your waste water management system is considered to be an improvement as: · the original single purpose septic tank has been replaced with a dual purpose tank which can handle both greywater and blackwater · new transpiration beds have been created · new spouting has been installed to the carport · the treatment of the kitchen waste has been improved by connecting it to the new septic tank. The work performed is more than just a repair to an existing system. As the work performed is considered to be an improvement, you are not entitled to a deduction for the entire cost of the work performed on the waste water management system. | Detailed Reasoning - Capital works deduction: Where a repair is considered to be capital expenditure, a deduction may be allowable under Division 43 of the ITAA 1997 over a period of time. Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works, including building and structural improvements, where a residential property is used for income producing purposes. The deduction is available on the cost of constructing structural improvements or extensions, alterations or improvements to structural improvements if construction started after 26 February 1992. For structural improvements, the annual capital works deduction allowable is 2.5 per cent of the construction expenditure for a period of 40 years, as long as the property is income producing and owned by you. Construction expenditure is the actual cost of constructing the capital works. TR 97/23 states that expenditure for repairs to property is capital expenditure if the expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety. Property is more likely to be an entirety, as distinct from a subsidiary part, if · the property is separately identifiable as a principal item of capital equipment, or · 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 · the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves, or · the thing or structure is a unit of property as that expression is used in the depreciation deduction provisions of the income tax law. A capital works deduction is calculated using the following formula: Construction cost * 2.5% * (days used / 365) The work performed on the waste water management system, installation of spouting and associated plumbing is considered to be structural improvements relating to the rental property. As the work performed is structural improvements, you are entitled to a capital works deduction for the year ending 30 June 2012.

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