Private ruling: Rental deductions - legal expenses
Date of advice: 21 August 2025
Published: 27 October 2025
Ruling period: Year ended 30 June 20YY | Year ended 30 June 20YY | Year ended 30 June 20YY | Year ended 30 June 20YY | Year ended 30 June 20YY
Date scheme commenced: 1 July 20YY

Ruling: Q1: Are you entitled to a deduction for the legal expenses under section 8-1of the Income Tax Assessment Act 1997 (ITAA 1997) as rental expenses? | A1: No.

Relevant facts and circumstances: You are the sole registered owner of the property. The property was used to produce assessable income. You signed a contract to purchase a block of land on DD MM 20YY. You and the builder entered into a domestic building contract for the construction of a single storey dwelling and garage on the property (the Works). Construction commenced on DD MM 20YY. You took possession of the property on DD MM 20YY. A dispute arose between yourself and the builder in relation to alleged defects in the works. The circumstances leading to the legal action: 1.Observed damage cracks to the walls throughout the house. 2.Internal Home Door wasn't closing properly and unable to close doors. 3.Foundation Movements & floor levels were dropping on east side due to large trees. 4.Floor levels were dropping further even after Root Barrier installed to protect from large trees. 5.Cracks on Garage floor Concrete Slab. 6.Plumbing underneath Concrete Slab was blocked & leaking due to Tree Roots getting into plumbing pipes. You took the legal action to fix the property, so it was safe for the tenant and to not have to keep paying maintenance for structural defects. On or about DD MM 20YY, you made an application against the Builder and another entity (the Parties) at an Administrative Tribunal (the Tribunal) proceeding to determine the issues comprised in the dispute. On DD MM 20YY a Deed of Settlement (the Deed) was issued between yourself and the Parties. After a hearing held at the Tribunal in which a settlement was agreed upon. The terms of the settlement are: • To avoid the further cost and inconvenience of litigation, and without any admission of liability, the Parties have agreed to settle all claims whatsoever between them in the Proceeding, either current or contingent on the terms set out in this Deed in full and final settlement of your claims against the Builder in the Proceeding, inclusive of costs and interest, the Builder agrees to pay you the Settlement Sum of $X by electronic funds transfer to your bank account by DD MM 20YY.Each Party shall bear and be responsible for its own costs arising out of or in connection with the Proceeding and the review and execution of this Deed. On DD MM 20YY a Deed of Settlement was issued between yourself and another entity. After a hearing held at the Tribunal in which a settlement was agreed upon. The terms of the settlement are: • To avoid the further cost and inconvenience of litigation, and without any admission of liability, you and the other entity have agreed to settle all claims whatsoever between them in the Proceeding, either current or contingent on the terms set out in this Deed. • In full and final settlement of your claims against the other entity in the Proceeding, inclusive of costs and interest, Cameron agrees to pay you the Settlement Sum of $X by electronic funds transfer to your Solicitor's Trust Account by DD MM 20YY. • You and the other entity shall bear and be responsible for their own costs arising out of or in connection with the Proceeding and the review and execution of this Deed. You provided details of legal and professional service expenses totalling $X.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 8-1 | Income Tax Assessment Act 1997 subsection 20-25(1) | Income Tax Assessment Act 1997 section 110-25 | Income Tax Assessment Act 1997 section 110-35 | Income Tax Assessment Act 1997 subsection 110-145(3) | Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision: Summary: Under section 110-25 of the ITAA 1997, your legal expenses will be included in the cost base of the CGT asset. | Detailed Reasoning - Detailed reasoning: Section 8-1 of the ITAA 1997 allows a deduction for all losses or 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. In determining whether a deduction for legal expenses is allowed under section 8-1 of the ITAA 1997, the nature of the expenses must be considered, as explained in Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634. The nature of the legal expense follows the advantage that is sought to be gained by incurring the expenses. Some legal expenses incurred in producing rental income are deductible. These include the costs of: • Evicting a non-paying tenant; • Taking court action for loss of rental income; • Defending damages claims for injuries suffered by a third party on your rental property. If the advantage to be gained is of a capital nature, then the expenses incurred in gaining the advantage will also be of a capital nature. Expenditure is capital in nature where it is made with a view to bring into existence an asset or advantage that is of an enduring benefit. Capital expenditure is characterised by the fact that it is usually a one-off payment and establishes, replaces or enlarges an income producing asset. The following are examples of expenses which are capital or of a capital nature: • Replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or a refrigerator); • Improvements, renovations, extensions and alterations, and • Initial repairs, for example, remedying defects, damage or deterioration that existed at the date you acquired the property. Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction. 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 work that is a renewal in the sense of a reconstruction of an entirety. Expenditure is capital in nature where it is made with a view to bring into existence an asset or advantage that is of enduring benefit. Capital expenditure is characterised by the fact that it is usually a one-off payment and establishes, replaces or enlarges the income producing asset. Part of the legal fees and other related expenses paid to building consultants that you have incurred are associated with the rectification of the structural damages to your rental property, and had these structural defects been rectified it would have 'brought into existence an asset or advantage that is of an enduring benefit' to your property and tenants. As such the legal fees and other related expenses associated with the structural defects to your rental property are an outgoing of a capital nature and are not deductible under section 8-1 of the ITAA 1997. | Detailed Reasoning - CGT cost base: As the expenditure is a capital expense, which is not deductible, we need to consider whether the expenditure can form part of the cost base of your rental property. Section 110-25 of the ITAA 1997 lists the 5 elements of the cost base. They are: 1. The total of the money you paid, or are required to pay, in respect of acquiring it; and the market value of any other property you gave, or are required to give, in respect of acquiring it (worked out as at the time of the acquisition). 2. The incidental costs you incurred. 3. The costs of owning the CGT asset you incurred. 4. Capital expenditure for the purpose or the expected effect of which is to increase or preserve the asset's value; or that relates to installing or moving the asset. 5. Capital expenditure that you incurred to establish, preserve, or defend your title to the asset, or a right over the asset. Section 110-35 of the ITAA 1997 details the second element of the costs base, incidental costs. Incidental costs are the costs you may have incurred to acquire a CGT asset or that relate to a CGT event. Subsection 110-35(2) of the ITAA 1997 details the first example of incidental costs as the remuneration for the services of a surveyor, valuer, auctioneer, accountant, broker, agent, consultant, or legal adviser. Taxation Ruling TR 95/35 CGT: treatment of compensation receipts (TR 95/35) details what constitutes the cost base for the disposal of the risk to seek compensation cases. The consideration in respect of the acquisition of the right to seek compensation includes the total acquisition costs incurred as a result of which the right to seek compensation arose. Example 8 in paragraphs 283 to 285 of TR 95/35 details a situation where the relevant asset is the right to seek compensation. In this case, the cost base was the acquisition costs plus legal costs associated with pursuing the claim against the offending parties. In your case, you engaged a lawyer to get the property fixed so it was safe for the tenant and to no have to keep paying maintenance for structural defects. The legal fees you incurred were directly related to contract dispute against the Builder and another entity and therefore would be included in your cost base as an incidental cost under section 110-35 of the ITAA 1997. You did not incur any other costs to 'acquire' the asset as the right to seek compensation arose when the breach of contract was discovered and did not result in any direct costs for you. Under section 110-25 of the ITAA 1997, your legal expenses relating to the contract dispute will be included in the cost base of the CGT asset. | Detailed Reasoning - Recoupment: Recoupment is defined in subsection 995-1(1) of the ITAA 1997 having the meaning given by section 20-25 of the ITAA 1997. Subsection 20-25(1) of the ITAA 1997 states that a recoupment of a loss or outgoing includes: a) any kind of recoupment, reimbursement, refund, insurance, indemnity or recovery, however, described, and b) a grant in respect of the loss or outgoing. Under subsection 110-45(3) of the ITAA 1997 expenditure does not form any part of any element of the cost base to the extent of any amount you have received as recoupment of it, except so far as the amount is included in your assessable income. | Detailed Reasoning - Application to your circumstances: In your case, the compensation was received in respect of issues with the initial construction or the permanent reduction in the value of the property, which is the relevant CGT asset. You continue to own the property after the receipt of the compensation payments and there was no CGT event occurring upon the receipt of the payments. Therefore, the payments are not capital proceeds received in respect of a CGT event/s occurring but are viewed as recoupments. Therefore, as the payments are not included in your assessable income, they cannot form any part of any element of the cost base of the property. Accordingly, the first element of the cost base of the property will be reduced by the amount of the payments, being the total of payments received as compensation.