Private ruling: Rental property deduction
Date of advice: 14 December 2020
Published: March 2021
Ruling period: Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Are you entitled to a repairs deduction for your share of the cost of the replacement of the driveway? | A1: No. | Q2: Are you entitled to a capital works deduction at the rate of 2.5% for your share for the replacement of the driveway? | A2: Yes.

Relevant facts and circumstances: You and your spouse purchased an investment property, which has been rented for several years. When you and your spouse purchased the property, the driveway was originally serviceable. Over the years the driveway was damaged by tenants to the extent it was required to be removed and new crushed rocks replaced and then compacted.

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

Reasons for decision: Detailed Reasoning - 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, to the extent that the expenditure is not capital in nature. The word repair is not defined within the tax legislation and takes its ordinary meaning. Repair involves a restoration of a thing to a condition it formerly had without changing its character ( W Thomas & Co Pty Ltd v Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710). Expenditure for repairs is of a capital nature where: • the work is an initial repair • the extent of the work carried out represents a renewal or construction of the entirety, or • the work results in a greater efficiency of function, therefore representing an improvement rather than a repair. Taxation Ruling TR 97/23 Income Tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 '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'. The ruling further states that repairs mean 'the remedying or making good of defects in, damage to, or deterioration of, property'. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. TR 97/23 states that with a repair, 'the work restores the efficiency of function of the property without changing its character. An "improvement", on the other hand, provides a greater efficiency of function in the property ... It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do'. It is acknowledged in TR 97/23 that 'to repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. However, 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. It is accepted that the work in question were undertaken to fix damage caused by the tenants, were not initial repairs and were not improvements. However, we must also consider whether any of the works constituted a replacement of an entirety. In Lindsay v. Federal Commissioner of Taxation [1961] HCA 93; (1960) 106 CLR 377 ( Lindsay's Case ), the High Court (Kitto J) held that expenditure incurred to renew a slipway was a renewal of an entirety and was not deductible as a repair under section 53 of the Income Tax Assessment Act 1936 (which was re-written as section 25-10 of the ITAA 1997). This conclusion was drawn on the basis that his honour considered the slipway to be a separately identifiable capital item, maintaining its own function. Substantially the whole of the old slipway had been demolished and replaced by a new slipway, comprising all new components and was a renewal of a separately identifiable item and not a repair. The Commissioner considered the issue of replacement of an entirety in the rental property context in ATO Interpretative Decision ATOID 2003/222 Income Tax Repairs: replacement of kitchen cupboards in a rental property . In that ATO ID, damaged kitchen cupboards in a rental property were replaced. The Commissioner considered that the cupboards were a separately identifiable thing representing an entirety in themselves. Consequently, their replacement constituted a replacement of an entirety and was capital in nature. Therefore, the expenditure was not deductible as a repair under section 25-10 of the ITAA 1997. However, the Commissioner considers that kitchen cupboards are capital works which are eligible for the 2.5% capital works deduction. As a capital works deduction is available, a depreciation deduction is not allowable (subsection 40-45(2) of the ITAA 1997). The principles from Lindsay's Case and ATO ID 2003/222 equally apply here. The driveway is a separately identifiable capital item with its own function and is, therefore an entirety in itself. The replacement is a renewal of an entirety and the expenditure is not deductible as a repair under section 25-10 of the ITAA 1997. The expenditure is capital in nature. | Detailed Reasoning - Capital works: Division 43 of the 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%. In your case, the replacement of the driveway in your rental property is capital works. Consequently, you are entitled to a 2.5% capital works deduction under Division 43 of the ITAA 1997. As a capital works deduction is available, a depreciation deduction is not allowable for the driveway.