Edited version of private advice

Authorisation Number: 1051998943915

Date of advice: 28 June 2022

Ruling

Subject: Rental property expenses

Question 1

Are you entitled to a deduction under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)for the expenses incurred in replacing the drainage system?

Answer

Yes.

Question 2

Are you entitled to a deduction under section 25-10 of the ITAA 1997 for the expenses incurred in paving?

Answer

No, it is capital expenditure and can be included in the cost base of the rental property for capital gains tax purposes.

Question 3

Are you entitled to a deduction under section 25-10 of the ITAA 1997 for the expenses incurred for the painting of internal rooms?

Answer

No, but you are entitled to a deduction under section 8-1 of the ITAA 1997.

Question 4

Are you entitled to a deduction under section 25-10 of the ITAA 1997 for the expenses incurred for various works?

Answer

Yes.

Question 5

Are you entitled to claim a deduction for the decline in value for replaced hot water system under Division 40 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XY

The scheme commences on:

20XY

Relevant facts and circumstances

There was a significant rain event at the property, which is a rental property.

The property was purchased a number of years previously.

The required repairs involved replacing the drainage system from the rear of the property which collects run-off from the back yard and half the roof areas to the street pit at the front of the property.

The existing drainage system ran through the garden bed under trees from the front of the house to the street and this drainage system was totally blocked and could not be cleared.

The drainage system at the rear of the property from the roof area was damaged by large tree roots from adjacent gum trees. This drainage also ran under concrete and could not be accessed from above without major concrete cutting.

In addition, to stop water running into the house, a hard surface was required along the back and side of the house, so that water could be channelled away from the house into the drainage system. Pavers were sourced to provide this surface.

This work was undertaken after tenants vacated but was impacted by COVID-19. The property again made available for rental when the works were completed.

Various other works were also carried out during this period.

To the best of your knowledge, none of the repairs were required at the time that the property was purchased as it was in good order.

You incurred all the expenditure for each of the works and are not expected to receive any insurance payments in relation to any of the work.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

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

All references made in these reasons for decision are to the Income Tax Assessment Act 1997 unless otherwise stated.

Section 25-10 allows a deduction for the cost of repairs to premises used for income producing purposes. However, subsection 25-10(3) does not allow a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction.

The term 'repair' means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired and contemplates the continued existence of the property. Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state, or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

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

Expenditure for repairs to property is capital expenditure if the expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety.

The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment' (Lindsay v Federal Commissioner of Taxation [1961] HCA 93).

Property is more likely to be an entirety, as distinct from a subsidiary part, 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 can provide 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 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.

Paragraphs 44 to 46 of TR 97/23 provide the following explanation in relation to repairs and improvements:

44. The meaning of 'repair' or 'repairs' is considered in paragraphs 12 to 30 of this Ruling. In the case of a 'repair', broadly speaking, the work restores the efficiency of function of the property without changing its character. An 'improvement', on the other hand, provides a greater efficiency of function in the property - usually in some existing function. It 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.

45. To distinguish between a 'repair' and an 'improvement' to property, one needs to consider the effect that the work done on the property has on its efficiency of function. This is the determinative test.

46. 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.

Improvements can be either capital works, where it's a structural improvement or capital allowances where the item is a depreciable asset.

Division 43 provides a deduction for capital works. Capital works is used to describe certain kinds of construction expenditure on buildings, structural improvements, extensions, and alterations.

Expenditure on landscaping and plant is not included as construction expenditure in accordance with subsection 43-70(2).

Section 40-25 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).

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.

Drainage system

You purchased the property more than xx years prior to discovering the deterioration to the drainage system.

The drainage system is part of the property and the stormwater drainage system. The replacement of the drainage system is not the replacement of an entirety but the replacement of a subsidiary part of the system.

The replacement was necessary to restore the functioning of the drainage system.

The expenses incurred in replacing the drainage system are therefore deductible as they were incurred during the period the property was held for income producing purposes and are attributable to damage that occurred during the income producing use of the property.

Pavers

The pavers are designed to divert rainwater away from the house. This will have the effect of improving drainage on the property. This is more than a restoration of the efficiency of the drainage system therefore it is not a repair.

Paragraph 43-70(2)(d) excludes expenditure on landscaping from construction expenditure therefore it cannot be claimed as a capital works deduction.

The expenses incurred in paving are capital and can be included in the cost base of the rental property for capital gains tax purposes.

Painting of internal rooms

Paragraph 92 of TR 97/23 states that:

Maintenance, as generally understood, includes the prevention of defects, damage or deterioration; a common example is the regular re-painting of business premises. The word 'maintenance' may in some contexts be the same as 'repair', and it may in some contexts have a wider meaning that includes repairing as well as other operations. Some kinds of maintenance work constitute 'repairs' in its context in section 25-10, for example, painting plant or business premises to rectify existing deterioration and to prevent further deterioration. Maintenance done to property that is not in need of repair, however, is not repair work and any expenditure for the work in these circumstances is not deductible under section 25-10.

The internal rooms were painted as they had not been painted since you purchased the property. The painting is not a repair, and where the painting does not amount to an improvement, the expenses incurred are deductible under section 8-1.

Various works

The work on each of these items involve the restoration of a part of the entirety. The expenses incurred in undertaking these repairs is deductible.

Hot water system

The hot water system can be described as plant and is a depreciating asset. You will be able to claim a deduction for the decline in its value whilst the property is being used to produce assessable income.

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