Edited version of private advice

Authorisation Number: 1052404301588

Date of advice: 11 June 2025

Ruling

Subject: Rental property deductions

Question 1

Can the cost of bathroom works be claimed as a repair expense under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Can the cost of bathroom works be claimed at the rate of 2.5% as a capital works expense under Division 43 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX XXXX 20XX

Relevant facts and circumstances

You acquired the property located at XX XX XX on or about XXXX 20XX (the property).

The property has been used to produce rental income since XX XXXX 20XX.

The property is used 100% for the purpose of generating rental income.

The property is owned on a passive investment basis only.

In XXXX 20XX a licensed plumber inspected the property and confirmed that the waterproofing membrane of a shower in your unit had failed causing leakage.

You provided a copy of an invoice from a plumber dated XX XXXX 20XX which outlines the work undertaken and the materials used.

You provided before and after photos in relation to the bathroom works.

You provided copies of invoices, quotes etc for the work undertaken.

The builder XXXX went into liquidation.

The developer XXXX was under a Deed of Company Arrangement (DOCA) Administration.

The defect warranty is void and all owners are responsible for fixing defects at their own cost.

There were 2 Prohibition Orders issued in relation to the unit building due to serious defects being identified in the construction of the building.

Relevant legislative provisions

Income tax Assessment Act 1997 section 25-10

Income tax Assessment Act 1997 Division 43

Income tax Assessment Act 1997 section 43-20

Reasons for decision

Deductions for repairs

Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes.

However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature. 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 97/23 Income tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable under section 25-10 of the ITAA 1997.

TR 97/23 states that in its context in 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 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.

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.

Paragraph 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.

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. 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.

An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer's assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property 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.

Correctly applied waterproofing is expected to last 10 to 15 years. However, in your case the waterproofing issues arose only a few years after construction was completed. This indicates that the waterproofing was not applied correctly when the unit was constructed. This conclusion is supported by the fact that 2 Prohibition Orders were issued in relation to the unit building due to serious defects being identified in the construction of the building. As the waterproofing was not applied correctly on construction, remedying that defect is an initial repair and therefore a capital expense. Consequently, the cost is not deductible under section 25-10 of the ITAA 1997.

Capital works

Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to building and structural improvements where a residential property is used for income producing purposes pursuant to section 43-20 of the ITAA 1997.

Although an immediate deduction is not available for the full cost of the work to the bathroom, a capital works deduction is allowed at the rate of 2.5% each income year while the property is used for income producing purposes.

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