Edited version of private advice

Authorisation Number: 1052024836868

Date of advice: 25 August 2022

Ruling

Subject: Rental - deduction for repairs

Question

Are you entitled to a partial deduction under section 25-10 of the Income Tax Assessment Act 1997 for the expenditure to complete water ingress remedial works to your property that was used for both private and income-producing purposes?

Answer

Yes.

This private ruling applies for the following periods:

Income year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You purchased a property in the year beginning 1 July 20XX

Around the time you acquired the property, a strata scheme inspection report was completed.

You used the property as your principal place of residence from the date of acquisition.

The property was rented some years later, in the year beginning 1 July 20XX.

The Lease agreement provided shows the terms of the lease.

The rent is managed by a real estate agent.

You provided a letter from the body corporation regarding necessary building repairs in the income year the property was rented. The letter provides information about the work.

You provided a report outlining further information about the repair work including the remedial activities to be completed.

You provided information about the builder and details of how the works will be paid for.

A special levy was introduced to pay for the cost of the works.

Your share of the levy for the income year the property was rented was $XX.

You have not received any insurance or other type of payment.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Does Part IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Summary

The work to be done to remediate damage caused by water ingress from is not considered to be a renewal or reconstruction of an entirety, not initial repairs or an improvement and the expense is in respect to an income producing asset. The expense meets the requirements of a repair and is deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

However as you held the property partly for non-income purposes and partly for income purposes, repair expenditure is only deductible to the extent to which the property was held in the year of income for income purposes.

Therefore, you are required to apportion your claim. Your claim will only be allowed to the amount applicable to the number of days your property was held for income-producing purposes in the income year ended 30 June 20XX.

Detailed reasoning

If you use a property only partly for the purpose of producing assessable income, you can deduct so much of the expenditure you incur to repair it as is reasonable in the circumstances, provided the expenditure is not capital in nature (section 25-10 of theITAA 1997).

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the circumstances in which expenditure incurred for repairs is an allowable deduction under section 25-10 of the ITAA 1997.

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 repairs (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property (paragraph 13 of TR 97/23).

Work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense) in property is not in itself a 'repair' unless it is done in conjunction with remedying or making good defects in, damage to, or deterioration of, the property (paragraph 14 of TR 97/23).

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. 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 (paragraph 15 of TR 97/23).

Expenditure incurred on an initial repair after a property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at that date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so whether the property is purchased or obtained under lease or licence by the taxpayer. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred; but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs (paragraph 59 of TR 97/23).

In appropriate circumstances, expenditure for repairs can qualify as a deduction even though the property has previously been held, etc., by the taxpayer for non-income purposes. This situation is different from an initial repair done to newly leased property, where the repair expenditure is capital in nature (paragraph 76 of TR 97/23).

A deduction is allowable under section 25-10 if, when the repair expenditure is incurred in a year of income, the property is held, etc., by a taxpayer for income purposes:

a)    even though the property has previously been held, etc., by the taxpayer for non-income purposes; and

b)    even though some or all of the defects, damage or deterioration arise from, or are attributable to, the taxpayer's holding, etc., of the property before its holding, etc., for income purposes; and

c)    provided that the repair expenditure is not capital expenditure.

If property is held, etc., in a year of income partly for income purposes and partly for non-income purposes, repair expenditure is only deductible to the extent that is reasonable in the circumstances of the case. The reasonableness test is an objective one and each case must be decided on its own merits. However, we would expect that the amount of expenditure allowable as a deduction under subsection 25-10(2) (or the old law, when read with subsection 53(3)) would ordinarily be calculated by reference to the extent to which the property was held, etc., in the year of income for income purposes (paragraph 79 of TR 97/23).

In your case, expenditure associated with the work done to remediate water penetration damage caused by water ingress constitute repairs or maintenance as the work does not change the character of the property and did not improve the efficiency of function of the property. The work done is necessary to fix damage caused by water penetration.

Based on various reports, we are satisfied the damage leading to the need for repairs did not exist at the time you acquired the property. Therefore the cost for the repairs is not considered to be on an initial repair.

You incurred the repair expenditure in a year of income on property held in earlier years for non-income purposes. The repair expenditure qualifies for a deduction under section 25-10 of the ITAA 1997 as the property is held for income purposes when the repair expenditure was incurred. However, as you used the property only partly for income-producing purposes during the income year in which the expenditure was incurred, you are entitled to a deduction for so much of the expenditure as is reasonable in the circumstances.

A simple example of the necessary calculation for apportionment of expenses where property is rented for part of the year is shown at Example 9 on page 9 of our Rental properties 2022 guide.

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