Private ruling: Rental property income and expenses
Published: September 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Can you claim the expenses for work carried out to the bathroom of your investment property as a deduction? | A1: Yes. | Q2: Can you claim a deduction for the insurance excess expense? | A2: Yes. | Q3: Should you include the amount awarded to you as assessable income? | A3: Yes.

Relevant facts and circumstances: You have a rental property which incurred damage as a result of a water leak in the bathroom. You purchased the property soon after completion. You had the property rented for almost three years when the tenant reported a problem with the shower waterproofing in the bathroom of the property. Over a period of more than 12 months you attempted to have the original builder repair the damage, however after they denied liability, you appointed another builder to carry out the work. The new builder carried out the repairs at a cost to you. You also had a cost in addition to the builders invoice amount, which was to cover your insurance excess. You then took the original builder to court and you were awarded an amount which covered your expenses for the work done, plus the insurance excess, and this was paid to you immediately.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 8-1 | Income Tax Assessment Act 1997 Subsection 20-20(2) | Income Tax Assessment Act 1997 Section 25-10.

Reasons for decision: Summary: 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. Taxation Ruling TR 97/23 provides guidelines on the deductibility of repairs. Generally, a 'repair' involves a restoration of a thing to a condition 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. TR 97/23 indicates that expenditure for repairs to property is capital in nature and is not deductible under section 25-10 of the ITAA 1997 if: · the works provide a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair', or · 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; or · the work is an initial repair. An 'entirety' is defined as something 'separately identifiable as a principal item of capital equipment' ( Lindsay v. FC of T (1961) 106 CLR 377 at 385). 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. As the damage and deterioration that occurred to your property can be attributed to the period of time that the property was used for income producing purposes you are entitled to claim a deduction under section 25-10 of the ITAA 1997 for the cost of any repair work. The costs incurred in remedying the damage caused by the water leak are not considered to be an initial expense, a renewal or reconstruction of an entirety or an improvement. It is accepted that you are merely restoring the bathroom to its previous efficiency by making good damage caused during the period of income earning from the property. Thus you are entitled to a repair deduction for the expense you incurred for the work to the bathroom area of your rental property under section 25-10 of the ITAA 1997. You are also entitled to claim a rental property deduction for the amount you paid for the insurance excess. | Detailed Reasoning - Assessable income: Under Subdivision 20-A of the ITAA 1997, certain amounts received by way of insurance, indemnity or other recoupment are assessable income if the amounts are not income under ordinary concepts or otherwise assessable. Under subsection 20-20(2) of the ITAA 1997, an amount you have received as recoupment of a loss or outgoing is an assessable recoupment if: (a) you received the amount by way of insurance or indemnity; and (b) you can deduct an amount for the loss or outgoing for the *current year, or you have deducted or can deduct an amount for the loss or outgoing for an earlier income year under any provision of this Act. For the recoupment of the loss or outgoing to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997, the amount you receive must be by way of insurance or indemnity. In your case the recoupment will not be received by way of insurance. However, it is considered that the amount you receive is by way of indemnity and is an assessable recoupment. Indemnity is not a defined term in the Income Tax Assessment Act s and therefore must be given its ordinary dictionary definition. In this respect indemnity includes compensation for damage or loss sustained. The issue of whether an amount is received by way of indemnity for the purposes of the predecessor provision to subsection 20-20(2) of the ITAA 1997 (paragraph 26(j) of the Income Tax Assessment Act 1936 ) has been considered in a number of cases including: Federal Commissioner of Taxation v. Wade (1951) 84 CLR 105; (1951) 9 ATD 337; 5 AITR 214, Robert v. Collier's Bulk Liquid Transport Pty Ltd (1959) VR 280, Goldsbrough Mort & Co Ltd v FC of T (1976) 76 ATC 4343, 6 ATR 580 ( Goldsbrough ); and Commercial Banking Company of Sydney Limited v. FC of T 83 ATC 4208 (1983); 14 ATR 142 ( Commercial Banking ). These cases make it clear that an amount received by way of indemnity is not restricted to amounts received under a contract of indemnity. This was made clear by Hunt J. in Commercial Banking who, referring to the decision in Goldsbrough , stated ... his Honour was correct in ruling that the expression "by way of... indemnity" should not be construed narrowly in the sense of "pursuant to a contract of indemnity". The cases also make it clear that an amount received 'by way of indemnity' would include a receipt pursuant to an antecedent obligation (whether by virtue of a contract, statute or a breach of some common law duty of care) to make good or compensate for a loss which arises after the obligation comes into existence. Therefore, the phrase 'by way of indemnity' broadens the range of receipts to be considered an assessable recoupment under subsection 20-20(2) of the ITAA 1997 to include receipts other than amounts received under a contract of indemnity. As you can deduct an amount for the outgoings for the insurance excess and for the repairs to the rental property, the recoupment, being the amount awarded by the court, will be an assessable recoupment under subsection 20-20(2) of the ITAA 1997. Therefore, you are required to include in your assessable income the total amount awarded to you.