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Authorisation Number: 1011728999496

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Ruling

Subject: Rental property expenses

Question 1

Are you entitled to claim a deduction for repairs of the following work to be carried out to the ground floor of your rental property?

· replacing of walls to the garage, stair case, laundry, bathroom, rumpus and bedrooms

· painting inside

· replacing door frames and doors

· replacing of ceiling

· replacing of kick boards to the kitchen cupboards

· repair rusting legs to deck

· repair wood rot to floor upstairs

· drain and acid wash the pool

· electrical work in replacing of GPO points to walls, data cabling to bedrooms, new power meters and wiring to distribution board

Answer

Yes

Question 2

Are you entitled to claim a deduction for decline in value for the following?

· replacement of air conditioners

· replacing of carpets and vinyl floor covering

· replacement of pump and chlorinator for pool

Answer

Yes

Question 3

Are you entitled to claim a capital works deduction for the following work carried out to your rental property?

· replacing light fittings to laundry, bathroom, hall, bedrooms and rumpus room.

· replacing built in wardrobes to bedrooms

· replacing bathroom vanity

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You have a rental property that has been tenanted for the past year.

You were to have new tenants occupy your rental property but due to major flooding to your property this did not occur.

Your rental property is currently uninhabitable as there was extensive flood damage to the entire ground floor which includes three bedrooms, bathroom and lounge/rumpus room.

The following repairs are required to bring your property back to a standard where it is liveable and can be rented again:

· replacing of walls to the garage, stair case, laundry, bathroom, rumpus and bedrooms

· painting inside

· replacing door frames and doors

· replacing of ground floor ceiling

· replacing of kick boards to the kitchen cupboards

· repair rusting legs to deck

· repair wood rot to floor upstairs

· replacing of air conditioners

· replacing of carpets and vinyl flooring both ground floor and first floor

· replacing built in wardrobes, bathroom vanity

· extensive electrical work to bring back to safety standards

· replacement of pump and chlorinator for pool

· drain and acid wash the pool

You are not able to claim insurance as your policy does not cover flood.

You have provided a list of the repairs and photos.

Summary

You are not entitled to a full deduction for the work to be completed on your rental property. Work such as the repainting inside, replacing of damaged walls, doors and frames, ceiling, kick boards to kitchen cupboard, rusting legs to deck , wood rot to floor upstairs and drain and acid wash the pool and electrical work in replacing of GPO points to walls, data cabling to bedrooms, new power meters and wiring to distribution board restore the efficiency of function, do not provide substantial improvement, and are considered repairs.

You are not entitled to a deduction for the replacement of air conditioners, carpets and vinyl flooring, pool pump and chlorinator as they are depreciating assets for which you can claim a deduction for the decline in value.

However, the replacement of, built in wardrobes, bathroom vanity and light fittings are considered capital expenditure and you are entitled to a deduction for capital works.

Detailed reasoning

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 Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710, 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 indicates 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,

· the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair',

· the work is an initial repair.

Replacement of a subsidiary part or an entirety

 TR 97/23 at paragraph 38 considers that a property is more likely to be an entirety if:

· the property is separately identifiable as a principal item of capital equipment;   

· 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;

· the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves,

· the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law.

According to paragraph 39 of the TR 97/23, property is more likely to be a subsidiary part rather than an entirety if:

· it is an integral part of some larger item of plant;

· the property is physically, commercially and functionally an inseparable part of something else.

In the case of W Thomas & Co Pty Ltd v. FC of T (1965) 14 ATD 78; (1965) 115 CLR 58, which involved a claim for general repairs to a building, it was said that the question was not whether the roof or floor or some other part of the building, looked at in isolation, was repaired as distinct from wholly reconstructed, but whether what was done to the floor or the roof was a repair to the building.

Repair or improvement

Paragraph 45 of TR 97/23 distinguishes between a 'repair' and an 'improvement' to property which one needs to consider the effect that the work done on the property has on its efficiency of function.

If the work entails the replacement or restoration of some defective, damaged or deteriorated part of the property, one does not focus on the effect the work has on the efficiency of function of the part. That is not determinative of whether the property is repaired or improved. It is a relevant factor to take into account, however, in considering the effect of the work on the property's efficiency of function. It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property.

In your case, you have a rental property that has been tenanted for the past year and due to recent flooding you have incurred expenses to repair the damage to the ground floor.

You have incurred expenses for the following work carried out to your rental property:

· replacing of walls to the garage, stair case, laundry, bathroom, rumpus and bedrooms

· painting inside

· replacing door frames and doors

· replacing of ceiling

· replacing of kick boards to the kitchen cupboards

· repair rusting legs to deck

· wood rot to floor upstairs

· drain and acid wash the pool

· electrical work in replacing of GPO points to walls, data cabling to bedrooms, new power meters and wiring to distribution board

The expenses that you incurred were to restore the property to its original state and function. You have not renewed or reconstructed an entirety.

As a result you have incurred expenses to restore your property to a rentable state. The above items are not considered to be capital in nature. Therefore, you are entitled to a deduction for these repairs.

Decline in value

Section 40-25 of the ITAA 1997 states that you can deduct an amount for the decline in value of a depreciating asset you hold to the extent that you use it for a taxable purpose. The term 'depreciating asset' is defined in subsection 40-30(1) of the ITAA 1997 as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

However, subsection 40-45(2) of the ITAA 1997 provides that 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.

Subsection 40-80(2) of the ITAA 1997 provides that the decline in value of a depreciating asset will be the cost of the asset if the cost of the asset does not exceed $300 and the asset is used predominately for the production of assessable income.

You are to replace the air conditioners, carpets and vinyl floor coverings, pool pump and chlorinator with a similar product and standard that was damaged due to the floods.

Expenses incurred to replace the air conditioners, carpets and floor vinyl, pool pump and chlorinator are capital in nature and not deductible as a repair under section 25-10 of the ITAA 1997. However, these items are depreciating assets as they have a limited effective life and can reasonably be expected to decline in value over the time they are used in the rental property.

Accordingly, a deduction for their decline in value is allowable under section 40-25 of the ITAA 1997.

Capital works

Section 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.

Section 43-10 of the ITAA 1997 requires that:

· the capital works has an area in which capital works is carried out, the work is begun after 30 June 1997, and the expenditure incurred is for capital works that are owned or leased by the taxpayer (section 43-75 of the ITAA 1997)

· there is an amount of construction expenditure incurred that is attributable to the capital works area (section 43-85 of the ITAA 1997)

· the construction area must be used in a deductible way at some time during the year of income for the purposes of producing assessable income.

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).

You have to replace built wardrobes, bathroom vanity and light fittings to the laundry, hall, bedrooms and rumpus room. Built in wardrobes are separately identifiable representing an entirety in themselves and the replacement of these results in an improvement or a renewal or reconstruction of an entirety. They are fixtures and therefore, a part of the building because they satisfy the 'degree of annexation' and the 'object of annexation' test that are generally applied to determine whether there is a fixture at common law. The built in wardrobes are not in place simply by their own weight but are fixed with the intention that they shall remain there indefinitely.

Similarly, the bathroom vanity and light fittings are considered to be capital improvements rather than a repair. Therefore, an immediate deduction is not available under section 25-10 of the ITAA 1997.

However you are entitled to a deduction for capital works under section 43-10 of the ITAA 1997 for these items.

Additional information

In the case of ceasing to hold a depreciating asset, a balancing adjustment event may occur. A balancing adjustment event occurs for a depreciating asset when you stop holding it such as the asset has been sold, lost or destroyed. If there is a balancing adjustment event, you need to calculate a balancing adjustment amount to include in your assessable income or to claim a deduction.

The Guide to depreciating assets 2010 at page 17 provides further information as to what happens if you no longer hold or use a depreciating asset. This guide is available on the ATO website www.ato.gov.au.

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