Edited version of your written advice

Authorisation Number: 1012782428595

Ruling

Subject: Works on a rental property

Question 1

Are you entitled to an immediate deduction for the following work undertaken on the bathroom of your rental property?

Replace bath

Replace wall and floor tiles

Replace basin

Replace soap, towel and toilet roll holders

Replace light fitting

Replace window in the bathroom wall with another item

Answer

No

Question 2

Are you entitled to a deduction for the decline in value for the following work undertaken on the bathroom of your rental property?

Replace bath

Replace wall and floor tiles

Replace basin

Replace soap, towel and toilet roll holders

Replace light fitting

Replace window in the bathroom wall with another item

Answer

No

Question 3

Are you entitled to a 2.5% capital works deduction for the following work undertaken on the bathroom of your rental property?

Replace bath

Replace wall and floor tiles

Replace basin

Replace soap, towel and toilet roll holders

Replace light fitting

Replace window in the bathroom wall with another item

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on:

1 July 2014

Relevant facts and circumstances

You have owned and rented a residential investment property for more than 12 years.

The unit is approximately 50 years old.

It has come to your attention through your property manager that the bathroom at this property requires a significant amount of work to bring it up to a standard that is safe to use.

The work you intend to carry out is as follows:

• replace the rusted bath

• replace all floor and wall tiles as some are chipped, loose or missing

• replace the chipped and cracked basin

• replace the broken and cracked soap, towel and toilet roll holders, and

• replace the window in the bathroom wall with another item.

The unit is currently tenanted.

You intend to re-tenant the property after the required work has been completed.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Question 1

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 denies a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 deals with the issue of deductions for repairs. Generally, a 'repair' involves a restoration of a thing to a condition it formally 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 (paragraphs 13-16 of TR 97/23).

TR 97/23 indicates that expenditure for repairs to property is capital in nature and not deductible under section 25-10 of the ITAA 1997 where:

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

• the extent of the work carried out represents a renewal or reconstruction of the entirety, or

• the work is an initial repair

TR 97/23 explains that an improvement is considered to be the provision of something new, which generally furthers the income-producing ability or effective life of the asset and generally of the thing improved. It lists a summary of indicative factors as follows:

• there is an increase in the value of an asset

• future repairs are now less likely as a result of the expenditure

• the asset's expected life is extended

In Case W77 89 ATC 698; AAT Case 5264 (1989) 20 ATR 3888 the owner of a rental property was denied a deduction for a remodelling of a bathroom, amongst other expenditure, where repair was needed because of age, deterioration and general wear and tear. It was held that the work done in remodelling the bathroom was extensive and could be described as a complete renovation designed to improve the unit rather than simply to restore it.

This principle applies in your case. The bathroom in the property was deteriorating. For this reason, you replaced the main features of the bathroom including the floor and wall tiles, hand basin, bath and other fixtures.

The replacement of all the items in the bathroom, as well as the re-tiling could not be considered to be merely remedying defects. Remedying defects would be limited to repairing or replacing only the damaged tiles, and so on. The expenditure in this case involves the renewal or modernisation of the bathroom of the property.

Hence, it can be argued that the work done to the property will extend its income producing ability and significantly enhance its saleability. The value of the property will be likely to have increased as a result of the work done and future repair expenses are likely to be reduced.

Therefore, the work done on the bathroom is considered to be a capital improvement and is not deductible as a repair under section 25-10 of the ITAA 1997.

Question 2

Division 40 of the ITAA 1997 allows a taxpayer to deduct an amount equal to the decline in value for an income year of a depreciating asset that they held for any time during that year.

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).

The decline in value of depreciating assets replaces the deduction for depreciation of 'plant' which was previously available under the ITAA 1997 Division 42. However, the concept of 'plant' (as defined in section 45-40 of the ITAA 1997) is still relevant as the definition of depreciating asset covers the meaning of 'plant' used under the former provisions as well as other assets that are wasting in nature.

Generally, when determining whether or not an item can be characterised as 'plant', consideration is given to the nature and function of the item in question (the 'functional test').

The concept of 'setting' is a crucial aspect of the functional test in that those items which are an 'integral part' of the property, or which form part of the 'fabric' of such property are not plant.

The extent to which an item can be removed from its setting and put in another setting without damage to the item or original setting is relevant when determining whether an item can be categorised as 'plant'.

In your case, you are replacing the old items in your bathroom with new items. As the new items will not be in place simply by their own weight but will be affixed to the property, it is considered that these items will be fixed with the intention that they shall remain there indefinitely, hence becoming part of the fabric of the building.

Therefore, you are not entitled to claim a deduction for the decline in value of the items you are replacing under Division 40 of the ITAA 1997.

Question 3

Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works including building and structural improvements where a residential property is used for income producing purposes. This deduction is referred to as a special building write-off.

The deduction is available on the cost of constructing structural improvements or extensions, alterations or improvements to structural improvements if construction of these improvements started after 26 February 1992.

For structural improvements, the annual special building write-off allowable is 2.5 per cent of the construction expenditure for a period of 40 years. Construction expenditure is the actual cost of constructing the capital works.

In your case, the costs of completing the works in the bathroom of the property are considered to be capital expenditure for the purposes of Division 43 of the ITAA 1997. As such, you are entitled to claim a capital works deduction at a rate of 2.5 per cent of the cost of the works. This deduction is available only while the property is available for rent, up to a maximum period of 40 years.

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