Private ruling: Rental property repairs
Date of advice: 5 February 2019
Published: May 2019
Ruling period: For the year ended 30 June 2018
Date scheme commenced: 1 July 2017

Ruling: Q1: Are you entitled to an immediate repairs deduction for the cost of the following work done to your rental property: ● new laminated kitchen bench top ● kitchen sink ● new kitchen taps ● removing and replacing splash back tiles in the kitchen | A1: No | Q2: Are you entitled to a capital works deduction for the work completed on your rental property? | A2: Yes

Relevant facts and circumstances: You purchased a rental property post 20 September 1995. The property has been used to produce assessable income since settlement. For a period of a year the property was unavailable for rent due to repairs. During this period major repair work was conducted on the property in relation to a wall on the property which had subsided. Work was required in the kitchen which was completed when the house was not available for rent. You undertook the following work: ● remove the existing tap, sink, damaged bench tops and the splash back tiles ● install new white laminate 32mm thick bench tops ● install new stainless-steel round sink with a tap mixer ● install new white tiles splash back ● remove waste materials The original kitchen laminate was made of particle board which was water damaged and had decayed over time. This damage to the kitchen presented a risk of injury and/or infection to the tenants. The damage had lifted the laminate. It was no longer water tight and resistant to water. The replacement of the sink did not pose a risk to the tenant however it was made of enamel which had scratches. You have not been able to provide a property inspection report detailing the condition of the kitchen.

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 40-25 | Income Tax Assessment Act 1997 Division 43

Reasons for decision: Summary: You are entitled to a deduction for the cost of repairs to premises used for income producing purposes providing the expenditure is not of a capital nature (section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)). 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. Expenditure incurred to remedy defects, damage or deterioration in existence at the date of acquisition of property is an initial repair. 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 entirety is defined as something separately identifiable as a principal item of capital equipment ( Lindsay v. FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201). An improvement provides a greater efficiency of function and involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property’s income producing ability, significantly enhance its saleability or market value or extend the property’s expected life. If the work done restores a previous function, or restores the efficiency of the previous function, it does not matter that a different material is used. The kitchen had decaying laminated particle board bench tops. The work involved the replacement of the laminate bench tops, splash back tiles, kitchen sink and taps. Existing materials were replaced with equivalent new materials. Remedying defects would be limited to repairing or replacing individual damaged items. Although your intention may have been to restore the efficiency of function of the items replaced, you have gone beyond repairing worn items to a renewal of the items in the kitchen as a whole. Therefore, when you are replacing the kitchen bench top, sink, taps and splash back tiles, the work is considered to be a capital improvement and is not deductible as a repair under section 25-10 of the ITAA 1997. These items are separately identifiable as principal items of capital equipment and the cost of replacing them is capital in nature. | Detailed Reasoning - Decline in value: You can deduct an amount equal to the decline in value for an income year of a depreciating asset to the extent that it is used for a taxable purpose (section 40-25 of the ITAA 1997). A taxable purpose includes the purpose of producing assessable income (subsection 40-25(7) of the ITAA 1997), such as rental income. A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used (subsection 40-30(1) of the ITAA 1997). Division 40 of the ITAA 1997 does not apply to capital works to the extent that an amount is or could have been deductible under Division 43 of the ITAA 1997. On this basis the items are not depreciating assets but are part of the setting of the income earning activity. As such they are not subject to deductions for their decline in value under section 40-25 of the ITAA 1997; however, a deduction may be allowable under Division 43 of the ITAA 1997 (subsection 40-25(2) of the ITAA 1997). | 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%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997). TR 93/23 states that expenditure for repairs is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of an entirety. Paragraph 38 of TR 97/23 states that a property is more likely to be an entirety 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. The kitchen sink, taps, bench top and splash back tiles are separately identifiable things representing an entirety in themselves. They are affixed permanently to the building and cannot be easily removed without causing damage. As such, they are considered to form part of the fabric of the building. The expenditure on replacing them results in a renewal or reconstruction of an entirety. The expenditure is not a repair but is capital in nature. An annual deduction of 2.5% of the cost of this item is allowable under Division 43 of the ITAA 1997. 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 rental property is 2.5%. A deduction cannot be made until the completion of the capital works. In your case, you replaced the kitchen in its entirety. Therefore, you are entitled to a deduction for capital works expenses incurred in replacing the kitchen.