Edited version of private advice

Authorisation Number: 1052107481070

Date of advice: 12 April 2023

Ruling

Subject: Rental property expenditure - repair deductions

Question

Was the expenditure you incurred in relation to installing the new drainage system at XXXXX (the property) deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

The work done installing the new drainage system is a renewal or reconstruction of an entirety. Alternatively, the installation of the new drainage system would be an initial repair. Both renewal or reconstruction of an entirety and initial repairs are capital in nature. Capital expenditure is excluded under section 25-10 of the ITAA 1997.

The other expenses that you incurred were closely related to remedying the failed drainage system and as such are not deductible.

This ruling applies for the following periods:

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

1. You purchased a residential rental property at XXXXXX (the property) in 20XX.The property was tenanted on 20XX.
2. You exclusively used the property for the purpose of producing assessable income.
3. Your tenants first alerted you to water ingress in 20XX. The water ingress got progressively worse and was exacerbated by significant rain events in the 20XX and 20XX income years.
4. In 20XX you engaged a plumber. They performed work during October 20XX through to January 20XX which proved to be ineffective. They advised you that to fix the water ingress, you would need to remediate or replace the failing external subsoil drainage system.
5. In May 20XX you engaged a new plumber to assess the damage. they began the work on the new drainage system in July 20XX. With the work concluding in March 20XX.
6. You removed the existing drains. This required propping of the neighbouring property, demolition of retaining wall, stairs, driveway, and boundary fence. After the new drainage system was installed, the retaining wall, stairs, driveway, and boundary fence were reinstalled.
7. Consequently, you also incurred expenditure on replacing the following at the property:

•         Fence

•         Steps

•         Retaining wall

•         Driveway

•         External walls waterproofing

8. You replaced the existing drainage system with a new drainage system

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Reasons for decision

Question

Was the expenditure you incurred in relation to installing the new drainage system at XXXXX (the property) deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

No. You cannot claim a deduction under section 25-10 of the ITAA 1997 for work done to remediate the drains because it was the reconstruction or renewal of an entirety, or alternatively an initial repair. Furthermore, the additional expenses incurred are closely related to remediating the drainage system and as such are not deductible.

Detailed reasoning

Section 25-10 of the ITAA 1997

Section 25-10 of the ITAA 1997 provides that you can deduct expenditure you incur for repairs to premises that you held solely for the purpose of producing assessable income. The ATO's view on what constitutes a repair, is outlined in Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23).

Was the property held solely for the purpose of producing assessable income?

The property was used for the sole purpose of producing assessable income.

Repairs or renewal or reconstruction of an entirety: TR 97/23

TR 97/23 states at paragraph 21 that a repair is a question of fact and degree.

What is a 'repair' for the purposes of section 25-10 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property.

Paragraph 85 observes that a repair involves the making good of defects, damage or deterioration including the renewal of parts and the word does not imply a total reconstruction.

Paragraph 36 states the following in distinguishing a repair from either a renewal or reconstruction of an entirety.

'Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety.'

The meaning of entirety is highlighted through paragraphs 37-38:

'37. 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. FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201), 'a physical thing which satisfies a particular notion' (the Lindsay case at 106 CLR 384; 12 ATD 201) and 'not necessarily the whole but substantially the whole of the [property] under discussion' (the Lindsay case at 106 CLR 383-4; 12 ATD 200). There is no one correct test for what is a subsidiary part and what is an entirety. Which approach to adopt depends on the facts in each particular case and, even then, the question is one to be answered in the light of all the circumstances it is reasonable to take into account (see Regent Oil Co Ltd v. Strick Inspector of Taxes [1965] 3 All ER 174 at 179; Brown (Inspector of Taxes) v. Burnley Football and Athletic Co Ltd [1980] 3 All ER 244 at 255).

38. Property is more likely to be an entirety 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 is capable of providing 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 in itself 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.'

Application to facts

We consider the work done to remedy the failing drainage system to be a reconstruction or renewal of an entirety because a separately identifiable entirety has been reconstrued or renewed. The old drainage system was replaced with a new drainage system. The facts do not suggest that you repaired a part of the old drainage system. Rather, you installed a new drainage system. This is more readily construed as reconstructing or renewing the entirety of the drainage system and not replacing a damaged subsidiary part of the drainage system. Renewal or reconstruction of an entirety is not a repair and is also capital in nature and, as a result, a deduction is not available under section 25-10 of the ITAA 1997.

Initial repairs

Expenditure you incur to remedy faults in the property that were present at acquisition are capital expenditure and not deductible under section 25-10 of the ITAA 1997.

TR 97/23, at paragraph 61, highlights that it is immaterial whether you were aware of the fault at the time you acquired the property. Paragraph 137 then explains that initial repairs to recently acquired property ought to be dealt with in the following way:

Expenditure for repairs to recently acquired property is fully deductible only if it involves the remedying of defects, damage or deterioration wholly attributable to the period in which the property is held, etc., by the taxpayer for income purposes. If, on the other hand, the expenditure involves putting the property in order suitable for use or the cost of remedying defects, or restoring damage or deterioration existing at the time of purchase, it is of a capital nature and not deductible under the old law. As a general rule of thumb, but subject to the facts in each particular case, repairs effected soon after the purchase of property often rectify defects in, damage to, or deterioration present in the property at the time of purchase.

Application to facts

In the event the work done to remedy the failing drainage was not a reconstruction or renewal of an entirety, but was a repair, then we think it was an initial repair. We have no evidence to indicate that the fault in the drainage system was not present when you acquired the property. In order for you to claim a deduction for remediating damage to the drainage system, it must be shown that the damage occurred during the period that you held it. The facts do not suggest that the drainage system failed solely as a result of damage occurring during the period that you held the property. In addition, since the water ingress occurred soon after you acquired the property, it may be the case that the drainage system was already damaged when you acquired the property. We acknowledge you may have been unaware of the failing drainage system before you acquired the property. However, knowledge of the fault is not required for a repair expense to be classified as an initial repair. The installation of the new drainage system would be an initial repair and therefore not deductible under section 25-10 of the ITAA 1997.

Are the other expenses deductible under section 25-10 of the ITAA 1997

In relation to projects which involve potential improvements and repairs, TR 97/23 states the following at paragraph 55:

'If some parts of the project can be effectively separated and considered in isolation from the rest of the project, they may still be repairs. '

Application to the facts

We consider that the other expenses are closely related to the installation of the new drainage system and are not deductible because they were only incurred as a result of or to facilitate the installation of the new drainage system. These other expenses cannot be separated and considered in isolation from the rest of the project. The new fence, steps, retaining wall, driveway and external wall waterproofing were all replaced to facilitate or as a consequence of the work done replacing the drainage system. These items were not repaired. These other expenses relating to the fence, steps, retaining wall, driveway and external walls waterproofing are not deductible under section 25-10 of the ITAA 1997 due to their close relationship with the installation of the drainage and the fact that they are not of themselves repairs.

Conclusion

The work described in this private ruling will be capital in nature and a deduction is not available under section 25-10 of the ITAA 1997. The work performed in remediating the drainage system is the replacement or renewal of an entirety, as the entire drainage system was replaced with a new one. Even if we formed the alternative view, that remediating the drainage system was a repair, it would have been an initial repair and subsequently capital in nature. The other expenses incurred are closely related to the installation of the new drainage system, and are not repairs deducible under section 25-10 of the ITAA 1997.

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