Edited version of private advice

Authorisation Number: 1052126867221

Date of advice: 23 June 2023

Ruling

Subject: Deductions - rental property repairs

Question 1

Are the works you have undertaken in relation to the underpinning of your rental properties, at X Street (Property 1) and X Avenue (Property 2) deductible as repairs?

Answer

Yes, to the extent the costs incurred in underpinning is attributable to repairing deterioration of the foundations from the time you commenced owning the rental properties in MM 20XX. Refer to Taxation Ruling TR 97/23 Income tax: deductions for repairs for further information on apportioning initial repair costs.

Question 2

Are the works you have undertaken in relation to the underpinning of your rental properties, at Property 1 and 2 considered capital works?

Answer

Yes, to the extent the costs incurred in underpinning is attributable to repairing deterioration of the foundations from the time the house was built in 19XX until the time you commenced owning the rental properties in MM20XX. Refer to Taxation Ruling TR 97/23 Income tax: deductions for repairs for further information on apportioning initial repair costs.

Question 3

Are the works you have undertaken to replace the roofing and guttering on your rental properties, at Property 1 and 2 deductible as repairs?

Answer

Yes.

Question 4

Are the costs you incurred to patch up the roof and remove mould from internal walls of your rental properties, at Property 1 and Property 2 deductible as repairs?

Answer 4

Yes.

This ruling applies for the following period:

For the income year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

In MM20YY, you purchased a duplex property (the property) as the sole owner on a single title, located on the corner of X Street (Property 1) and X Avenue (Property 2).

The property was constructed in approximately 19XX.

On DDMM20YY and prior to purchase of the property, you obtained a building inspection report from X Pty Ltd.

The building inspection of Property 1 stated the following:

Significant items requiring immediate action

•         Wall crack/s have occurred due to external geotechnical (soil) environmental conditions around the building (highly reactive clay soil conditions aggravated by subterranean water table conditions and/or excess water formation induced by subterranean rock, clay or sand). It is recommended that the problem be assessed by a geotechnical/foundation engineer as soon as possible for rectification solutions.

•         Foundation failure/ structural cracking in the wall from movement through the foundations, this due to foundation failure from either external weathering and of lack of protection from either surface drainage, sewer pipes, weathering (rain) near pathways and or reactive soil conditions around the foundations. This will need to be further investigated by structural engineer for under pinning if cracking gets bigger over seasonal periods, if patching is done these may open up.

•         The two corners of the house, front left and back left have dropped due to extreme soil conditions and the ground movement.

Defects other than major defects

•         Down pipes not connected to the storm water system have the potential to cause differential settlement to the footings

•         Internal brick walls are cracking above the windows and doors openings. This is common for the age of the house due to the absence of masonry articulation joints (control joints) which would help prevent cracking during seasonal movement in the foundations/footings. The crack/s can be repaired by installing a control joint and/or patching and painting, but these crack/s may reappear during seasonal periods.

The building inspection of Property 2 stated the following:

Defects other than major defects

•         Internal brick walls are cracking above the windows and doors openings. This is common for the age of the house due to the absence of masonry articulation joints (control joints) which would help prevent cracking during seasonal movement in the foundations/footings. The crack/s can be repaired by installing a control joint and/or patching and painting, but these crack/s may reappear during seasonal periods.

•         Brick wall cracking due to the exterior wall area having movement through the foundations from either external weathering, lack of protection from either insufficient surface drainage away from foundations, "no seal at the path and is causing weathering to enter the footings" and or reactive soil conditions around the foundations. All external water management will need to be considered to make sure the soil moisture conditions stay constant during seasonal periods.

•         Chimney flue damage and/or ceiling lining damage possibly due to flue flashing leak. Recommend contacting a licensed roof plumber for repairs as soon as possible.

The wall cracks and the foundation issues discovered in the inspection reported in MM20YY, did not prevent you from renting either property to tenants. You did not have the foundational issues rectified at this time.

At the time of acquisition, the roof was in a serviceable state and did not pose any concerns other than the chimney flue damage and/or ceiling lining damage mentioned in the building inspection report. You had this issue rectified by X and were invoiced in MM20XX.

In MM20XX, Property 2 was first available to rent to tenants.

In MM20XX, Property 1 was first available to rent to tenants.

In MM20YY, the tenants of Property 1 notified the property manager that mould was evident in multiple rooms of the property, primarily on the ceilings and cornices. This was the first time you learned there was mould growth at the property.

Contractor W (a mould specialist) inspected the property and established the following issues in the report dated DDMM20XX:

•         Blistering to the ceiling of all three bedrooms

•         Mound growth to the bedroom 1 ceiling and bathroom

•         Coving coming away to bedroom 1, 2 and bathroom, and

•         Blistering of paint to the laundry.

The tenant noticed the mould growth and blistering of the paint started in MM20XX:

•         The moisture readings were only found elevated in bedroom 1 at the time of attendance

•         The moisture is probably coming in from the guttering

•         The property has insufficient down pipes, and

•         The roof potentially needs attention near the outer wall and requires an inspection.

A professional was engaged (Contractor X) to attend the property and completed a temporary seal to some areas of the roof, as well as a gutter clean. X Real Estate was invoiced for the work on DDMM20 for $X.

You accepted a quote from a professional (Contractor Y) to replace the existing roof and gutters on the entire property. As well as install 4 spin away air vents to 4 exhaust points. The quote was dated DDMM20XX.

A professional was engaged (Contractor Z) to inspect the property's footings given the growth of mould was worse in some rooms and you were advised to stabilise the property before the roof replacement. The company recommended that the entire property be underpinned to strengthen the foundations. You accepted the quote for Contractor Z to undertake the underpinning works.

On DDMM20XX,the tenants of Property 1 opted to break their lease and vacate the property for the works to be completed.

Property 2 remained tenanted for the entirety of the works.

The foundations of both Property 1 and Property 2 were underpinned and Contractor Z invoiced you on DDMM20XX for $X, on DDMM20YY for $X and finally on DDMM20YY for $X. The total cost of the underpinning works were $X.

The existing iron sheeted roof was replaced with Colourbond sheeting and Contractor Y invoiced you on DDMM20YY for $X.

On DDMM20XX new tenants moved into Property 1 as the works were complete.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 subsection 25-10(3)

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 110-25

Reasons for decision

Question 1

Are the works you have undertaken in relation to the underpinning of your rental properties, at X Street (Property 1) and X Avenue (Property 2) deductible as repairs?

Answer

Yes, to the extent the costs incurred in underpinning is attributable to repairing deterioration of the foundations from the time you commenced owning the rental properties in MM20XX. Refer to Taxation Ruling TR 97/23 Income tax: deductions for repairs for further information on apportioning initial repair costs.

Question 2

Are the works you have undertaken in relation to the underpinning of your rental properties, at Property 1 and 2 considered capital works?

Answer

Yes, to the extent the costs incurred in underpinning is attributable to repairing deterioration of the foundations from the time the house was built in 19XX until the time you commenced owning the rental properties in MM20XX. Refer to Taxation Ruling TR 97/23 Income tax: deductions for repairs for further information on apportioning initial repair costs.

Question 3

Are the works you have undertaken to replace the roofing and guttering on your rental properties, at Property 1 and 2 deductible as repairs?

Answer

Yes.

Question 4

Are the costs you incurred to patch up the roof and remove mould from internal walls of your rental properties, at Property 1 and Property 2 deductible as repairs?

Answer

Yes.

Summary

A portion of the underpinning expenses incurred are considered to be an initial repair in respect to an income producing asset. Therefore, this portion of the expenses are capital in nature and not deductible under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997).

As the expense incurred for underpinning has a capital component, you can dissect and apportion the total expense to reflect the proportion that represents capital expenditure that is an initial repair. You should apply the principles as per paragraph 64 of TR 97/23 Income tax: deductions for repairs, in undertaking the apportionment. That is, the expense can be apportioned on a time basis between the cost of repairing deterioration that occurred before the purchase date in MM 20XX and the cost of repairing the deterioration that occurred after the purchase date in MM 20XX.

The roofing, guttering and mould repairs are considered to be a repair and immediately deductible under section 25-10 of the ITAA 1997.

Detailed reasoning

Subsection 25-10(1) of the ITAA 1997 allows a deduction for the cost of repairs to premises, or a part of the premises, used solely for income-producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs that are considered capital expenditure. Division 43 of the ITAA 1997 allows deductions for capital works expenditure.

The following are examples of expenses which are capital or of a capital nature:

•         replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator),

•         improvements, renovations, extensions, and alterations, and

•         initial repairs, for example, in remedying defects, damage or deterioration that existed at the date you acquired the property.

Taxation Ruling TR 97/23explains 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.

Entirety

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.

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 (the Lindsay case)).

In the Lindsay case, the taxpayer company was a slip proprietor and ship repairer. It claimed a deduction for the cost of reconstructing one of two slipways. In finding that the work was not repairs, Kitto J rejected the taxpayer's submission that either the whole slip (comprising the slipway, hauling machines, cradles, and winches by which vessels were manoeuvred on to it) or the whole of the business premises containing the slipway should be regarded as the relevant entirety. His Honour decided that the slipway was an entirety by itself and not a subsidiary part of a larger whole.

In the case of WG Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58; (1965) 14 ATD 78, 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.

Relevantly, paragraph 40 of TR 97/23 describes a building as the entirety, and something that is part of the building, such as a roof or wall is considered to be a subsidiary part rather than the entirety.

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 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.

Repair is distinct from improvement

Paragraphs 44 to 47 of TR 97/23 discuss improvements.An improvement provides a greater efficiency of function in the property. 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.

Paragraph 46 states. 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 consider, 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.

Paragraphs 48 to 52 of TR 97/23 discuss the use of different materials. In particular, paragraphs 49 and 50 provide:

49. Whether the use of a more modern material to replace the original material qualifies as a repair is a question determined on the facts of each case. It is restoration of a thing's efficiency of function (without changing its character) rather than exact repetition of form or material that is significant.

50. If the work done restores a previous function to the property, or restores the efficiency of the previous function, it does not matter that a different material is used. Even if the work done using different material enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair. However, the greater the work enhances the efficient functioning of the property, the more likely it is that the work constitutes an improvement

Initial repair

Paragraph 59 of TR 97/23 states that expenditure incurred on an initial repair after a rental property is acquired, where the expenses are incurred in remedying defects, damage, or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10 of the ITAA 1997.

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.

Paragraphs 60 of TR 97/23 states that the main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage, or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs the expenditure.

Paragraph 61 of TR 97/23 provides it is not considered material whether you were aware of the condition or the need for repair of the property at the time of purchase. It is also immaterial whether the purchase price reflected the need for repairs.

At paragraphs 63 to 66 and 136 to 140 of TR 97/23 the Commissioner sets out his view as to the ability to dissect or apportion initial repairs.

Initial repair costs can be dissected or apportioned

Paragraph 63 of TR 97/23 states an initial repair expense can be dissected or apportioned to allow a deduction under section 25-10 of any part of the expense that remedies deterioration arising from the holding, etc., of the property by the taxpayer for income purposes after it was acquired. No dissection or apportionment is available, however, if the repair expenditure is necessitated by a defect or damage to property because this expenditure is either wholly attributable to the holding, etc., of the property before the taxpayer acquired it or wholly attributable to the holding, etc., of the property by the taxpayer for income purposes after it was acquired.

At paragraph 64, it states dissection or apportionment on a time basis is appropriate if repair costs are incurred either due to defects (whether expected or unexpected) that arise gradually over an extended period or due to wear and tear or deterioration that occurs:

(a) in part before the property is acquired by a taxpayer; and

(b) in part in the course of the taxpayer's holding, etc., of the property for income purposes.

Further, paragraph 66 of TR 97/23 states if repair costs are attributable either to damage before the property is acquired by a taxpayer, or to defects that emerged suddenly and matured by the time of acquisition of the property, no deduction is allowable under section 25-10 in accordance with paragraph 59 of this Ruling. If repair costs are attributable either to damage that occurs during the taxpayer's holding etc., of the property for income purposes or to defects that emerge suddenly and mature during that time, a deduction is allowable if the other general principles stated in the ruling are satisfied.

Expenditure on initial repairs lacks a connection to the income producing activities of the property and is considered an additional cost of acquiring the property or an improvement in the quality of the property you acquired. Initial repair expenditure relates to the establishment of the profit - yielding structure. It is capital expenditure and is not deductible under section 25-10 of the ITAA 1997.

Application to your circumstances

The roofing, guttering and mould repairs are considered to be repairs under section 25-10 of the ITAA 1997 and immediately deductible in the income year you incurred these costs.

The foundations of the property were strengthened by underpinning. The main issue is whether this expense was incurred to remedy defects, damage or deterioration that already existed when you became owner of the property. Expenditure on initial repairs after a rental property is acquired is capital in nature and not immediately deductible as repairs.

It was advised in the building inspection report dated DDMM20YY, that there was failure, cracking and movement of the foundations. In addition, two corners of Property 1 were reported to have dropped.

Based on the information provided we are not satisfied all the deterioration to the foundations occurred since you became owner of the property in 20XX. We consider the underpinning will rectify deterioration that has occurred over time and since the foundation was first laid. It was advised the roof was in a serviceable state and did not pose any concerns when ownership began. However, you were not able to provide documentation from a third party to verify the condition of the roof prior to your ownership. The rental inspection reports from the property manager do not comment on the condition of the roof or roof tiles.

For these reasons, the underpinning works include an element of initial repairs. You are not entitled to claim an immediate deduction for this portion of the expense under section 25-10 of the ITAA 1997.

As the expense incurred for underpinning has a capital component, you can dissect and apportion the total expense to reflect the proportion that represents capital expenditure that is an initial repair. You should apply the principles as per paragraph 64 of TR 97/23 in undertaking the apportionment. That is, the expense can be apportioned on a time basis between the cost of repairing deterioration that occurred before the purchase date in MM20YY and the cost of repairing the deterioration that occurred after the purchase date in MM20YY.

For example, if the building was constructed approximately 50 years ago and the asset has been used by you for income producing purposes for approximately 4 years / 50 years at the time you incurred the expense, an acceptable time-based apportionment would be 8% of the total expense claimable as an immediate deduction under repairs. The remaining 92% is to be claimed as a capital works deduction under Division 43 of the ITAA 1997 for future income years while the property is genuinely available for rent or included in the third element of the cost base for capital gains tax purposes as per section 110-25 of the ITAA 1997.

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