Edited version of your private ruling

Authorisation Number: 1012468917691

Ruling

Subject: Rental property expenses

Question 1

Are you entitled to a deduction for repairs for the following:

· excavation and removal of earthenware sewer pipe, replacing with PVC pipe, and reconnection to outlets,

· disconnection and reconnection of the hot water system, and fitting of replacement valve,

· replacing hot and cold water pipes, and

· cleaning existing drain, lifting and re-laying existing PVC drainpipes?

Answer

Yes.

Question 2

Are you entitled to a capital works deduction for the following:

· installation of a new drainage vent,

· replacing existing brick paving with concrete, and

· new concrete paving?

Answer

Yes.

Question 3

Are you entitled to a deduction for the cost of removing trees and existing plants and landscaping work performed at your rental property?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2013

The scheme commenced on

1 July 2012

Relevant facts and circumstances

You own a rental property which is built on clay soil.

The property moved substantially on its foundations, which caused major cracking of the walls.

You had a building consultant investigate.

Findings included that a leaking sewer pipe combined with poor drainage on the same side of the house caused the clay soil to swell.

The consultants report indicated that the type of footing/foundation system supporting the house is at a depth of 450mm, which was commonplace for the area at the time of construction.

The report noted that contemporary footings on the same site would be at a depth of 1 metre to better tolerate the clay soil and drainage conditions of the area.

Following the consultants recommendations, you engaged a civil engineer specialising in drainage, pipe leakage and waterproofing.

At this stage, you were unaware of any problem with existing drains, however the civil engineer recommended testing existing drains and services which could be contributing to the problem.

Subsequent testing showed some earthenware sewer sections were damaged or blocked.

The advice of the report was to engage a licensed plumber to carry out any work on the property sewer, and that this should be done before the other site and drainage works.

Drainage works included:

· disconnection and removal of the hot water system to gain access to the sewer

· excavating and removing the existing earthenware sewer pipes, and replacing them with PVC pipe which was connected to basin, toilet, shower, sink and laundry outlets

· re-installing the hot water system, complete with new duo valve to replace existing unit which was not functioning

· replacing hot and cold water pipes after they were pulled out while removing a tree stump in the back yard

· flushing and clearing of the existing property drain, and lifting and re-laying existing PVC drainpipes

· installation of a new drainage vent

· replacing existing brick paving with concrete

· construction of new concrete paving, and

· removal of existing planting in a lower area and landscaping including topsoil/seeding.

Palm Tree removal

You removed a palm tree which was close to a drainage pipe.

You have other palm trees which are very close to a neighbouring fence and threatening to collapse across the fence.

All of the palm trees were at the property when you purchased it and did not present a problem then.

You are not eligible to receive any insurance settlement in respect of any of these issues with your rental property.

Relevant legislative provisions

Income Tax assessment Act 1997 Section 8-1

Income Tax assessment Act 1997 Section 25-10

Income Tax assessment Act 1997 43-10

Reasons for decision

Deduction for work performed on property

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to a rental property.

To be eligible to claim such an expense you must be holding the property for the purpose of gaining or producing assessable income, and the expenses must not be capital in nature.

Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.

The meaning of repairs

The term repairs is not defined in section 25-10 of the ITAA 1997. Therefore, it is necessary to look at its ordinary meaning. Paragraph 13 of Taxation Ruling TR 97/23 states the following:

the word repairs has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.

At paragraph 44, the ruling goes on to state:

 In the case of a repair, broadly speaking, the work restores the efficiency of function of the property without changing its character...

Repair is distinct from renewal or replacement

Renewal, replacement or reconstruction of the whole or substantially the whole of a thing or structure (entirety) is likely to be considered a capital improvement rather than a deductible repair.

What is an entirety?

Determining what is an entirety is a question of fact in each case. According to TR 97/23, property is more likely to be an entirety if:

(a) the property is separately identifiable as a principal item of capital equipment

(b) the thing or structure is an integral part, but only part, of entire premises and is capable of providing a useful function without regard to any other part of the premises

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

(d) the thing is a unit of property as that expression is used in the capital allowances deduction provisions of the income law.

In the case of W Thomas and Co Pty Ltd v. FC of T (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710 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. It was held that the roof would be considered to be part of the building and the work done on the roof was a repair. This view is confirmed in TR 97/23 at paragraph 40.

Improvement or repair

When work is done to restore or fix a damaged item, we need to determine if the work undertaken is a repair or an improvement. Repairs generally restore the item to its former function and efficiency whereas improvements increase an items functionality and/or efficiency.

A repair may increase the items efficiency slightly and still be classified as a repair. However, where the items function or efficiency is improved substantially or the work changes the function of the item, the work is considered to be an improvement and capital in nature.

Costs relating to improvements are not deductible as repairs but may qualify for a capital works deduction.

Your repair expenses

You have

· removed and reconnected the hot water system to allow access to the sewer

· replaced a valve in the hot water system which was not working

· removed and replaced part of the earthenware sewer with PVC pipe

· replaced hot and cold water taps after they were pulled out when removing a tree stump in the back yard

· cleaned the existing drain, and

· lifted and re-laid existing PVC pipes.

The work done by replacing the above items, including the temporary removal and replacing of the hot water system and its valve, and cleaning the existing drain is not an initial repair, does not result in greater efficiency of function and is not a renewal or reconstruction of an entirety. Therefore, the work to the hot water system, earthenware and PVC sewer pipes, including cleaning the PVC pipes, lifting and relaying them, and replacing the hot and cold water pipes are considered to be repairs which are deductible under section 25-10 of the ITAA 1997.

Capital works deduction

Section 43-10 of the ITAA 1997 allows a taxpayer to claim a deduction for capital expenditure incurred in constructing buildings, or extensions, alterations or improvements to buildings.

Capital works deductions are also available for the cost of structural improvements to a property, for example, adding a pergola, patio or carport, sealed driveway, retaining wall or fence. Landscaping is not a structural improvement.

In the case of residential rental properties, the deduction is generally spread over a period of 25 or 40 years. The deduction is limited to 100% of the construction expenditure. No deduction is allowable until the construction is completed.

Deductions may only be claimed for the period during the year a property is rented or available for rent.

In your case, the works done to provide the new drainage vent, replacing existing brick paving with concrete and new concrete paving have been classified as being capital in nature. This work is considered to be capital works for the purposes of Division 43 of the ITAA 1997 as the work was not undertaken to restore or fix a damaged item. The works are considered to be improvements and capital in nature.

You are entitled to claim an annual capital works deduction at a rate of 2.5% for these capital works. This deduction is available while the property is owned by you and being rented or available for rent, up to a maximum period of 40 years.

Removal of trees and existing plants and landscaping costs

Section 8-1 of the ITAA 1997 allows a deduction for losses and outgoings which are incurred in the course of gaining or producing assessable income. However, no deduction is allowed where the losses or outgoings are capital, or are of a capital, private or domestic nature or another provision prevents the taxpayer from deducting it.

The cost of removing trees and plants and landscaping the property are not considered to be repairs as you are not restoring the efficiency or function of an item. These costs are capital in nature and therefore are not deductible under the general deduction provision of section 8-1 of the ITAA 1997.

No deduction is allowable for the cost of removing the trees and existing plants and landscaping the property as the expense is not a repair, is capital in nature and does not come within the meaning of a capital works expense. These expenses may be taken into account when calculating any capital gain or loss upon the disposal of the rental property.

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