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Edited version of private ruling
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Ruling
Subject: Rental property expenses
Are you entitled to an immediate deduction for repair work to be undertaken to resolve water seepage in the yard of your rental property?
No.
This ruling applies for the following period:
Year ended 30 June 2011
The scheme commences on:
1 July 2010
Relevant facts and circumstances
You have owned a rental property for a number of years.
From tenant complaints you established that a problem arose with the water drainage to the backyard of your rental property.
You confirmed by a building report and the local council that the water issue related to seepage and was your responsibility.
You sought professional advice and incurred expenses for excavating, landscaping and plumbing.
You have provided a detailed quote for the work undertaken.
Summary
You are not entitled to an immediate deduction for work to be undertaken to resolve a water seepage problem to the yard of your rental property as the cost of the landscaping and drainage work is a capital expense.
Detailed reasoning
Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) allows a deduction for all losses and outgoings to the extent they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or exempt nature.
Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income-producing purposes, to the extent that the expenditure is not capital in nature. Section 25-10(3) of the ITAA 1997 precludes a deduction for capital expenditure.
Taxation Ruling TR 97/23 explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10 of the ITAA 1997.
The word 'repair' is not defined within the tax legislation. Accordingly, it takes its ordinary meaning. 'Repair' involves a restoration of a thing to a condition it formerly had without changing its character (W Thomas & Co v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710).
A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. To repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997.
Paragraph 44 of TR 97/23 discusses the distinction between a 'repair' and an 'improvement' to property. Paragraph 44 states:
In the case of a 'repair', broadly speaking, the work restores the efficiency of function of the property without changing its character. An 'improvement', on the other hand, provides a greater efficiency of function in the property - usually in some existing function. 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 willextend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.'
In your case, the work to be undertaken is to alleviate a problem that has arisen. The work is not to repair or replace a part of something or correct something that is already in existence which has become worn out or dilapidated. The work is classified as landscaping and drainage which would provide a greater efficiency of function to the property.
Therefore, if the work undertaken essentially improves the efficiency of function of the property, or adds value to the property rather than simply repairs, the work will be treated as a capital improvement. Accordingly, an immediate deduction for the cost of the work is not deductible under section 8-1 of the ITAA 1997 or section 25-10 of the ITAA 1997.