Private ruling: Rental Property Deductions
Ruling period: Year ended 30 June 2010
Date scheme commenced: 1 July 2009

Ruling: Q1: Can you claim an immediate deduction for all of your strata management fees that were used to pay for the remedial works on your rental property? | A1: No | Q2: Can you claim a 2.5% capital works deduction for the strata management fees that were used to pay for the remedial works on your rental property? | A2: Yes

Relevant facts and circumstances: You acquired a rental unit in an apartment complex. Just over a year after purchasing the property, a consultant carried out investigations in relation to movement and cracking of the apartment complex. The consultant subsequently made recommendations for remedial works to be carried out. The remedial works involved: Under pinning of the building to stabilise cracking, Concrete spalling repairs to prevent further deterioration of the balconies and walkways, and Replacement of balustrading to comply with safety standard requirements. In regards to the remedial works, you were required to deposit money into the strata management special purpose fund.

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 and | Income Tax Assessment Act 1997 Section 43-25.

Reasons for decision: Summary: The strata management fees for the remedial works do not qualify for an outright deduction as they are considered to be capital in nature. However, you are entitled to claim a 2.5% capital works deduction for the strata management fees that were used to pay for the remedial works on your rental property. | Detailed Reasoning - Detailed reasoning: 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. Section 25-10 of the 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. Paragraphs 13 -16 of TR 97/23 specifically deals with the ordinary meaning of repairs. 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 (whether expected or unexpected) during the passage of time (paragraph 15 of TR 97/23). There are several issues which would exclude expenditure from being considered to be incurred as a repair. These are 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, or · the work is an initial repair. | Detailed Reasoning - Initial repair: If work is carried out to remedy defects, damage or deterioration that existed at the date of acquisition it is considered an initial repair and any expenditure incurred is considered capital in nature. The cost of affecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred. 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, you purchased a rental unit and within 15 months of owning this property a consultant identified the need for remedial works to be carried out on the apartment complex. The cause of the remedial works was as a result of the movement and cracking of the property. It is considered that the requirement for the remedial work has occurred over time and would have existed at the time you purchased the property. Therefore, as the special levy payment was to repair a defect existing when you acquired the property, the repair is considered an initial repair and as such is capital in nature. As a result, you are not entitled to a deduction for the special levy payment under section 8-1 or 25-10 of the ITAA 1997. | Detailed Reasoning - Capital works deductions: Section 43-10 of the ITAA 1997 provides an income tax deduction for capital works attributable to a construction expenditure area that is owned or leased by the taxpayer and used during the income year for the purposes of producing assessable income. Deductions based on construction expenditure apply to capital works such as: · a building or an extension - for example, adding a room, garage, patio or pergola · alterations - such as removing or adding an internal wall, or · structural improvements to the property - for example, adding a gazebo, carport, sealed driveway, retaining wall or fence. Section 43-25 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 spread over a period of 40 years at a rate of 2.5% per annum. The remedial works carried out on your investment property are considered to be capital works for which a deduction is available. Therefore you are entitled to a capital works deduction at a rate of 2.5% per annum for the special levy payment under section 43-10 of the ITAA 1997.

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