Edited version of private advice

Authorisation number: 1052242102225

Date of advice: 10 May 2024

Ruling

Subject: Rental property - repairs v capital expenditure

Question 1

Is the restoration work completed on the damaged downpipe considered a repair and therefore an allowable deduction under section 25-10 of the Income Tax Assessment Act 1997(ITAA 1997)?

Answer

Yes.

Question 2

Is the installation of the channel drain considered to be a repair and therefore an allowable deduction under section 25-10 of the ITAA 1997?

Answer

No.

Question 3

If the answer to question 2 is no, is the installation of the Channel Drain considered to be capital works and therefore deductible as capital works under Division 43 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commenced on:

1 July 2020

Relevant facts and circumstances

You purchased a property in mid 20XX.

The property has been rented out since mid-to-late September 20XX and you have not lived in it at any time.

The property is currently being rented.

In early 20XX, heavy rainfall caused flooding in the garage of the property.

The garage is slightly below street level, and excess rainfall came down the driveway into the garage.

On these occasions, damage occurred to the tenant's belongings in the garage.

There was also a problem with the downpipe at the rear of the garage that caused overflow issues due to damage to the downpipe.

The issues regarding the problems of flooding occurred in early 20XX and not prior to this.

Repairs were required to keep the property suitable for tenants.

Your appointed plumber attended your property and reported on the following issues related to the flooding:

•         Stormwater charged at front and blocked; however, they carried out high pressure jetting to main line and found it to be all clear.

•         Downpipe behind garage blocked. They attempted high pressure jetting, but they were unable to clear the blockage. Carried out visual inspections and found the pipe to be severely blocked under garage floor. They recommended due to location of issue that a rerun of the storm water downpipe to your garden or dig into backyard to connect to other downpipe several metres away to ensure a correct repair.

•         The driveway has no drainage along front of garage causing water to flood into it every time heavy rain occurs.

Following this your plumber recommended installing a channel drain in front of garage to divert water, along with re-running the affected down pipe at rear of garage to this channel drain.

Your plumber proposed an "Installation of channel drain in front of garage and re-run rear downpipe to new channel drain " to remedy the situation, and this was agreed to.

The supplied invoice from your plumber provides costs for the drain across the end of the driveway/beginning of garage and the cost of remediation of the old downpipe. Option 1 as stated on the invoice is only for the down pipe and option 2 is for both the downpipe and driveway drain. The latter option was chosen.

The works were complete in early 20XX, and you have fully paid this expense.

The original condition report you received upon the purchase of the property in mid 20XX did not indicate any plumbing structural defects at purchase regarding the downpipes, and did it not mention the need for a drain at the foot of the driveway.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for the cost of repairs to a rental property.

To be eligible to claim such an expense you must be holding the property for the purpose of gaining or producing assessable income, and the expenses must not be capital in nature.

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.

However, where an expense for work carried out to a rental property is considered to be capital in nature, no deduction is allowable under section 25-10 of the ITAA 1997. This will be the case if the work carried out is:

•         an 'improvement' rather than a 'repair', or

•         an 'initial repair'.

Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) contains the Australian Taxation Office (ATO) view on the circumstances in which an expense for work carried out on an income producing capital asset (such as a rental property) can be fairly described as a repair expense, as opposed to an expense for an improvement or an initial repair.

The meaning of repairs

The term repairs is not defined in section 25-10 of the ITAA 1997. Therefore, it is necessary to look at its ordinary meaning.

Paragraph 13 of Taxation Ruling TR 97/23 states the following:

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 repaired (being defects, damage, or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.

At paragraph 44, the ruling goes on to state:

In the case of a repair, broadly speaking, the work restores the efficiency of function of the property without changing its character...

Improvement or repair

When work is done to restore or fix a damaged item, we need to determine if the work undertaken is a repair or an improvement. Repairs generally restore the item to its former function and efficiency whereas improvements increase an items functionality and/or efficiency.

A repair may increase the items efficiency slightly and still be classed as a repair. As stated in paragraph 16 of TR 97/23:

A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair

However, where the item's function or efficiency is improved substantially or the work changes the function of the item, the work is considered to be an improvement and capital in nature.

Initial repairs

TR 97/23 states that expenditure incurred to remedy defects in, damage to, or deterioration of a (rental) property is an 'initial repair' if the defect, damage, or deterioration:

•         existed at the time of acquisition, and

•         did not arise from the income producing operations of the owner of the property.

However, TR 97/23 specifies that the main consideration in determining whether work carried out is an 'initial repair' is the appearance, form, state, condition, and functional efficiency of a property at the time of acquisition.

A repair carried out after acquisition of a property will be an 'initial repair' if the repair was due when the property was acquired, in the sense that there was a need for the repair to restore or maintain the property's efficiency of function at the time of acquisition. In other words, if a property is neither in good order when it was acquired, nor suitable for use for the intended income producing purposes, then repairs carried out after acquisition may be properly characterised as 'initial repairs'.

Application to your circumstances

Restoration work completed on the damaged downpipe

In your case, you purchased a property in mid 20XX, which has been rented out since mid-to-late 20XX, and is still currently being rented.

In early 20XX, heavy rainfall caused flooding in the garage of the property.

The garage is slightly below street level, and excess rainfall came down the driveway into the garage.

Your appointed plumber attended your property at this time and recommended a rerun of the storm water downpipe at the back of your garage to your garden, or dig into backyard to connect to other downpipe several metres away to ensure a correct repair.

There was also a problem with this downpipe that caused overflow issues due to damage to the downpipe.

Your appointed plumber also recommended the installation of a channel drain in front of garage to divert water, given that there was no drainage at the front of your driveway.

The repairs you incurred for the restoration work completed on the damaged downpipe are not classed as an initial repair, given that the original condition report you received upon the purchase of the property in mid 20XX did not indicate any plumbing structural defects at purchase regarding the downpipes, and did it not mention the need for a drain at the foot of the driveway.

In addition, we consider that the restoration work on the damaged downpipe restored it to its former function and efficiency, without any significant improvement to its functionality and/or efficiency.

As such, the work carried out to complete the restoration of the damaged downpipe is an allowable repair deduction under section 25-10 of the ITAA 1997.

Installation of the channel drain

In your case, whilst we acknowledge that the purpose of the installation of the channel drain at the front of your garage was to prevent any future damage to items, the fact remains that the channel drain was installed at the front of your garage, where there previously wasn't one there.

This cannot be classed as a repair, as this situation doesn't fall under the meaning of what a repair is in accordance with TR 97/23.

As such, the work carried out to install the channel drain is not an allowable repair deduction under section 25-10 of the ITAA 1997.

Deductions for capital works

Section 43-10 of the ITAA 1997 operates to provide a deduction for capital expenditure on capital works used to produce assessable income. A deduction under section 43-10 of the ITAA 1997 is based on the amount of construction expenditure. This is defined in subsection 43-70(1) of the ITAA 1997 as capital expenditure incurred in respect of the construction of the capital works.

Capital works include buildings and structural improvements or an extension, alteration, or improvement to a building.

This will include the addition of a channel drain at the front of your garage, which is a structural improvement to your driveway and therefore capital in nature.

Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a rental property is 2.5% over a period of 40 years. A deduction cannot be made until the completion of the capital works.

In your case, you installed a channel drain at the front of your garage which is a structural improvement to that area.

Therefore, you are entitled to a deduction rate for capital works of 2.5% over a period of 40 years for this capital expenditure.

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