Edited version of private ruling

Authorisation Number: 1011659461190

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Ruling

Subject: Rental property expenses

1. Are you entitled to claim a deduction for the costs of the following repairs to your rental property?

· repairs to the balcony

· replacing damaged floors, walls

· painting and tiling of bathroom and balcony

Yes.

2. Are you entitled to claim a deduction for capital works for the costs incurred in replacing the kitchen to your rental property?

Yes.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You own a unit in a multi residential complex which has been rented since you purchased it.

You provided a copy of the building and pest report at the time of purchase showing no activity of termites to be present.

You have provided a copy of a letter from insurers and consultants declining an insurance claim by your body corporate for remedial works relating to some design and defects to your unit and another unit of the complex.

You have provided copies of a complaint and a claim with the builder but you were unsuccessful.

You ceased to rent the unit and carried out repairs.

You have provided a copy of a letter from the builder confirming that termite damage had caused the outside balcony to move and water had entered the unit.

The work included:

· replacing parts of flooring and walls of a bedroom and kitchen on the lower floor of the unit

· timber trusses and tiles to the balcony

· replacing a damaged wall in the ensuite and replacing of wall tiles

· replacing damaged kitchen.

No additions or improvements were made other than what was required to bring the property to its former state.

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 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 case), 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 a property is of a capital nature where:

· the work is an initial repair, or

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

· the work results in an improvement in the property rather than a repair.

What is entirety?

In the W Thomas & Co case, 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.

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.

Repair

TR 97/23 states that with a repair, 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. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do.

Paragraph 16 of TR 97/23 states that to repair property, improves to some extent the condition it was in immediately before the 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 45 of TR 97/23 distinguishes between a 'repair' and an 'improvement' to property which one needs to consider the effect that the work done on the property has on its efficiency of function.

In your case, you were required to carry out repairs to your unit due to termite and water damage. The work involved repairing the balcony of the unit, replacing parts of the walls and flooring, tiling, painting and replacement of the kitchen. The work carried out has restored the unit to its former state.

The works performed in repairing the balcony, damaged walls and flooring, tiling and painting constitute repairs as the work carried out is merely a replacement or renewal of parts of the rental property that were damaged. The property has been restored to its former state, restoring the efficiency of function without changing its character, using the same materials. The work undertaken does not represent a renewal or reconstruction of the entirety as the work carried out was to subsidiary parts of the whole building.

Therefore, you are entitled to a deduction for the cost of repairs to the balcony, walls, flooring, tiles and painting of your rental property 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 buildings and structural improvements where a residential property is used for income producing purposes.

Section 43-10 of the ITAA requires that:

· the capital works has an area in which capital works is carried out, the work is begun after 30 June 1997, and the expenditure incurred is for capital works that are owned or leased by the taxpayer section 43-75 of the ITAA 1997

· there is an amount of construction expenditure incurred that is attributable to capital works area (section 43-85 of the ITAA 1997), and

· the construction area must be used in a deductible way at some time during the year of income for the purpose of producing assessable income.

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 residential rental property is 2.5%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997).

You have replaced the kitchen in your unit. Kitchen cupboards are separately identifiable representing an entirety in themselves and the replacement of these results in an improvement or a renewal or reconstruction of an entirety. They are fixtures and therefore, a part of the building because they satisfy the 'degree of annexation' and the 'object of annexation' tests that are generally applied to determine whether there is a fixture at common law. The kitchen cupboards are not in place simply by their own weight but are fixed with the intention that they shall remain there indefinitely.

Therefore, an immediate deduction is not available under section 25-10 of the ITAA 1997.

However, you are entitled to a deduction for capital works under section 43-10 of the ITAA 1997 for the kitchen cupboards.