Edited version of private ruling

Authorisation Number: 1011650755073

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Ruling

Subject: Rental property - repairs/capital works

Are you entitled to a deduction for the cost of cladding the asbestos walls of your rental property with fibre cement weatherboards?

Yes.

This ruling applies for the following period:

Year ended 30 June 2011

The scheme commences on:

1 July 2010

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You purchased a rental property (a dwelling) several years ago. Since your purchase, the dwelling has always been rented or been available for rent. It has been rented at commercial rates.

The dwelling was constructed a few decades ago and parts of the external walls were clad with asbestos fibro sheeting.

On purchase the building report showed the dwelling was in good condition.

The property is in an exposed coastal location and has deteriorated during the time you have been earning rental income.

The exterior paint is peeling badly and needs to be fixed in order that the dwelling remains a viable rental property.

Due to the fibro contained asbestos it is not possible to prepare the surface for painting due to the carcinogenic properties of the asbestos.

You had the option of either bricking over the exterior walls or cladding the exterior walls with another material. You chose the cladding because it was a cheaper alternative than the bricking. The material to be used is fibre cement weatherboards.

You have provided a quote from the company who is currently undertaking the cladding work. You paid a deposit in the current income year and will pay the balance on completion which will be in the same income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10.

Reasons for Decision

Section 25-10 of the Income Tax Assessment Act 1997 (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 word repair is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. In W Thomas & Co v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710 (W Thomas & Co), it was held that a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. It is the restoration of efficiency in function rather than the exact repetition of form or material that is significant.

Taxation Ruling TR 97/23 indicates that expenditure for repairs to property is of a capital nature where:

· the extent of the work carried out represents a renewal or reconstruction of the entirety, or

· the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or

· the work is an initial repair.

In your case, it is necessary to consider whether the use of fibre cement weatherboards for cladding, rather than painting the asbestos walls, which was not an option legally, would be considered the replacement of a subsidiary part or an entirety and whether it would actually constitute a repair or an improvement.

Replacement of a subsidiary part or an entirety

TR 97/23 at paragraph 38 considers that a 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.

According to paragraph 39 of the TR 97/23, property is more likely to be a subsidiary part rather than an entirety if:

· it is an integral part of some larger item of plant, or

· the property is physically, commercially and functionally an inseparable part of something else.

In the case of W Thomas & Co, 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.

In your case, the building is itself considered to be the entirety. The exterior walls would be considered a subsidiary part of the building.

Improvement vs Repair

Repairs generally improve the condition of the property. However substantial improvements, additions, alterations, modernisations and reconstructions are not repairs. Some of the factors which indicate an improvement as opposed to a repair include:

· the modification work has effected an improvement to the asset

· there is greater efficiency of function of the property

· there is an increase in the value of the asset

· the expenditure reduces the likelihood of future repairs.

According to TR 97/23, the Commissioner accepts that the use of a different material does not necessarily prevent the work from being a repair, provided the work merely restores a previous function to the property or restores the efficiency of the previous function. 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.

In your case, legally the walls could not be painted due to the dangers of the asbestos. Paragraph 26 of TR 97/23 discusses expenditure incurred in controlling health risks from dangerous substances. The ruling explains that work done to a property in controlling health risks associated with the use of dangerous substances, such as asbestos, does not qualify as a repair for the purposes of section 25-10 of the ITAA 1997 unless the work remedies or makes good defects in, or damage to, or deterioration (in a mechanical or physical sense) of, the property.

Thus, the fact that for legal purposes a different material had to be used, will not automatically mean the use of the fibre cement weatherboard cladding is not a repair. To be allowable under section 25-10 of the ITAA 1997 the expense must meet the general repair requirements.

In the case of Wates v. Roland (1952) 2 QB 12, the floor of a house had rotted from dampness and a tiled floor was installed. The new floor was held not to be an improvement but a repair. It was considered that the floor had merely been replaced by its modern equivalent.

TR 97/23 provides that 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 materials enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair. The test is whether there is a sufficient degree of improvement to justify characterising the expenditure as capital and therefore excluding it from deductibility.

In your situation, your primary purpose in adding the fibre cement weatherboard cladding is to repair the damaged exterior walls which cannot be painted due to the fact that the walls contain asbestos and cannot be prepared safely for painting.

It is considered that the fibre cement weatherboard cladding which will be used in place of painting the existing asbestos walls will constitute a repair as the change in material will not enable the property to perform its function more efficiently than previously. It cannot be said that the installation of the fibre cement weatherboard cladding to the exterior walls will improve the function of efficiency of the walls than if you had the option of painting the walls. The walls will merely be repaired by its modern equivalent and restore the original function to the exterior of the property.

Initial repairs

Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure and not deductible, if the defect, damage or deterioration:

· existed at the time of acquisition of the property, and

· did not arise from the operations of the person who incurs the expenditure.

In your case, you purchased the rental property several years ago and the building report on purchase showed the dwelling was in good condition. Therefore, the repair to the exterior walls would not constitute an initial repair as the deterioration of the walls occurred during the time when you were earning income from the property.

Thus, you are entitled to a deduction for the cost of cladding the asbestos walls of your rental property which cannot be prepared for painting in the current income year.