Private ruling: Rental deductions
Date of advice: 6 June 2023
Published: 7 August 2023
Ruling period: Year ended 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Is the replacement of the retaining wall a repair and therefore an immediate deduction? | A1: No. | Q2: Is the replacement of the clip lock roof a repair and therefore an immediate deduction? | A2: Yes. | Q3: Is the plastering and painting carried out on the internal rooms a repair and therefore an immediate deduction? | A3: Yes. | Q4: Is the electrical, plumbing and tiling work considered capital works? | A4: Yes. | Q5: Is the replacement of the Rangehood, Stove, Toilets, blinds, air conditioning units & vanity units considered the replacement of depreciating assets? | A5: Yes.

Relevant facts and circumstances: You own an investment property. You have owned this property for an extended period of time. The property has been rented since that time. Flats/units located on the property and are all connected. The property was rented immediately before it was deemed unsafe, and the tenants moved out. The property was rented immediately after the repair and rectification work had been complete. Several years ago, there was a storm event in the area of the property. The property incurred significant damage in the storm event. The rear retaining wall was damaged in the floods. The damage caused instability, and therefore a dangerous situation. The property was vacated several months later and the work on the wall repair commenced, and the work was completed several months later. The wall was braced for several months while further reports were sought, and insurance claims made. A significant percentage of the damage to the wall was attributed to the flood event. The wall was fully replaced with similar material. An insurance payout has been received by you in relation to the wall and it has been declared in the relevant tax return. The entire roof has been replaced. The roof has been on the property for several decades. It was a flat clip-lock roof. The roof was leaking and causing damage to the interior of the property. The original roof had no insulation and only intermittent areas of plastic sheeting protecting the interior from the exterior roof. To comply with current building standards, the roof was replaced and re-pitched to ensure no interior condensation continued. The repair commenced several; years ago and were completed a few months later. Internally, due to water damage there were significant repairs required to all flats/units at the property. The work required was equally spread across all flats/units and they are almost identical in how they now look. The plasterwork had significant water damage which needed fully replacing. This meant that the rooms that had this damage and mould needed the electricity to be re-wired, and where applicable re-plumbed and re-painted. The bathroom had serious mould issues behind the laminated panel lining which caused it to be loose. The baths and vanities were required to be removed to fix these issues and the plumbing was brought up to standard. The Rangehoods and lighting were in various stages of repair and required replacement.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 25-10 | Income Tax Assessment Act 1997 section 40-25 | Income Tax Assessment Act 1997 section 43-30 | Income Tax Assessment Act 1997 section 43-140

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. 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. In W Thomas & Co v. FC of T (1965) 115 CLR 58, it was held that a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. It is the restoration of efficiency in function rather than the exact repetition of form or material that is significant. Taxation Ruling TR 97/23 Income tax: deductions for repairs deals with the issue of deductions for repairs. TR 97/23 provides that expenditure for repairs to property is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of the entirety (paragraphs 36-42), or the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair' (paragraphs 44-58). Taxation Ruling TR 97/23 states: • 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. • 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. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10.' An 'entirety' is defined as something 'separately identifiable as a principal item of capital equipment' ( Lindsay v. Federal Commissioner of Taxation (1960) 106 CLR 377 at 385). Property is more likely to be an entirety, as distinct from a subsidiary part, if (TR 97/23): • 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. Division 43 of ITAA 1997 provides for a system of deducting capital expenditure incurred in the construction of buildings and other capital works used to produce assessable income. Section 43-30 of the ITAA 1997 provides that you cannot deduct any amount for a period before the construction is complete. Section 43-140 of the ITAA 1997 sets out the way you must use your area in an income year for a deduction to be allowed under section 43-10 (the main deduction provision). The relevant use depends on the time when the capital works began (Column 1) and the type of capital works (Column 2). Section 40-25 of the ITAA 1997 allows a deduction for the decline in value of a depreciating asset that you hold. A depreciating asset is an asset that can reasonably be expected to decline in value over time it is used (section 40-30 of ITAA 1997). Depreciating assets are those items that can be described as plant, which do not form part of the premises. These items are usually: separately identifiable; not likely to be permanent and expected to be replaced within a relatively short period and not part of the structure. Examples of assets that deductions for decline in value can be applied to include timber flooring, carpets, curtains, appliances like a washing machine or fridge and furniture. | Detailed Reasoning - Immediate deduction for depreciating assets costing $300 or less: Where a depreciating asset costs less than $300 you are able to claim an immediate deduction rather than depreciate the asset over a period of time where the asset has been used for income producing activity. The immediate deduction is available if all of the following tests are met in relation to the asset: • it cost $300 or less n you used it mainly for the purpose of producing assessable income that was not income from carrying on a business (for example, rental income where your rental activities did not amount to the carrying on of a business of letting rental properties) • it was not part of a set of assets costing more than $300 that you started to hold in the income year, and • it was not one of a number of identical, or substantially identical, assets that you started to hold in the income year that together cost more than $300 Therefore, the expenses that are below $300 can be claimed as an immediate deduction. | Detailed Reasoning - Question 1 retaining wall:: The original retaining wall was investigated by an insurance assessor, who made a recommendation for the wall to be replaced in full. Therefore, the replacement of the wall goes beyond restoring the property to its original state. In this case, the whole of the retaining wall was to be replaced. These changes represented both a renewal or reconstruction of an entirety, and an improvement to a fixed capital asset. Your expenditure on replacement of the retaining wall is not deductible outright in the income year in which it is incurred, because it is capital expenditure. A deduction may be available under the capital works provisions. The capital works provisions allow a deduction for certain capital expenditure on the construction of buildings and other capital works which are used for the purpose of producing assessable income. We note that you have highlighted paragraph 168 of TR 97/23 which set out an example which you believe is consistent with your case. Paragraph 169 goes on to say: 169. Note that there is an alternative view that the circumstances of this example may, in fact, amount to the replacement of an 'entirety'', or an improvement. Although the decision in this matter is a borderline one, we consider that, on balance, the marginally better view - in keeping with our longstanding position on this matter - is that the facts of this example amount to the making of a repair. Our ATO view is that the example in paragraph 168 constitutes a repair, and not an improvement. Alternative views are provided for the sake of completeness but they are not taken to represent our position. | Detailed Reasoning - Question 2 roof:: Paragraph 40 of TR 97/23 specifically states that a roof is only part of a building and does not constitute an 'entirety'. The building itself is the 'entirety'. As such, a replacement of a roof would not generally represent a renewal or a reconstruction of an entirety (as the house would be classed as the entirety). Where a property is used for income producing purposes and the replacement of the roof - is not an initial repair, - is not an improvement, - the material for the new roof is the same or very similar as the old roof, and - the repair work does not result in a greater efficiency of function, such that it represents an improvement rather than a repair of the roof, a deduction is allowable under section 25-10 of the ITAA 1997 (as long as those roof repairs can be separately identified where a roof is being repaired as part of an overall upgrade to a property). The work carried out on the roof is considered to be a repair. | Detailed Reasoning - Question 3 Plastering and painting: Plastering and painting of the internal building is considered to be a repair and an immediate deduction for the expense associated with this is allowable. | Detailed Reasoning - Question 4 Electrical, plumbing work and tiling: The electrical, plumbing and tiling are considered to be capital and an immediate deduction is not allowable. You are able to claim a capital works deduction. | Detailed Reasoning - Question 5 Rangehood, Stove, Toilets, blinds, air conditioning units & vanity units: The Rangehood, Stove, Toilets, blinds, air conditioning units & vanity units are depreciating assets. Taxation Ruling 2022/1 (TR 2022/1) considers the effective life of depreciating assets. The ruling sets out the effective life of the above assets.