Edited version of private ruling

Authorisation Number: 1011661047388

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Ruling

Subject: Rental property expenses

Question 1

Can you claim your share of a deduction for work done to the jetty of your rental property as repairs?

Answer: No

Question 2

Can you claim your share of a capital allowance deduction for the work done to the jetty of your rental property?

Answer: Yes

This ruling applies for the following period

Year ended 30 June 2010

The scheme commenced on

1 July 2009

Relevant facts

You purchased a rental property in the early 1990's and have rented it since then.

Part of the rental property is a jetty comprised of a walkway, attached to a landing at the seaward extremity.

You undertook substantial work to the walkway of the jetty to bring it back to a safe and well maintained condition.

The end landing of the jetty had been repaired approximately a year before the work was done to the walkway of the jetty, and no further work was undertaken on the landing.

Inspection by the builders showed the jetty walkway was too degraded and dangerous to be adequately repaired to a safe standard.

All of the concrete piers had extensive amounts of concrete cancer.

The jetty joists and decking were infested with termites and wood rot.

The nails holding the decking boards down were rusted away, and the jetty handrail was rusted and unusable.

Repairs undertaken were complete removal and replacement of all the walkway decking and joists, along with all of the piers under the walkway.

All new materials matched the existing dimensions and specifications.

No enlargements or upgrades were undertaken.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Section 8-1

Reasons for decision

Summary

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

Where the work involves a renewal in the sense of a reconstruction or replacement of the entirety, rather than the restoration of the property by renewal or replacement of subsidiary parts of a whole, a deduction for the cost of repairs is not allowed.

In your situation, it is accepted that the walkway and landings form an entirety. However the walkway forms a substantial part of the entirety, and as everything in the walkway had been replaced it is considered that there has been a renewal of a substantial part of the entirety.

Therefore, you are not entitled to a deduction for repairs for the work done to the jetty.

However, you are entitled to a capital works deduction for the costs of the work done to the jetty.

Detailed reasoning

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.

Subsection 25-10(3) of the ITAA 1997 precludes a deduction for repairs where the expenditure is of a capital nature.

Before a repair is deductible the expenditure must not be an initial repair or an improvement.

In your case it is accepted that the work done to the jetty was not an initial repair as you have held the jetty for a significant time. It is also accepted that the work undertaken replaced the worn and damaged section of the jetty with similar materials and there has been no change to the functionality of the jetty as a result of the expenditure.

Consideration of whether the work constitutes the replacement of an entirety (which would constitute an improvement) is a question of fact and degree having regard to the extent of the work performed. At paragraph 114 of Taxation Ruling TR 97/23 it is stated that "Renewal, replacement or reconstruction of the entirety (i.e., the whole or substantially the whole) of a thing or structure is an improvement rather than a deductible repair".

TR 97/23 provides guidance on when something is more likely to be an entirety. TR 97/23 provides that it is more likely to be an entirety if:

(a)    The property is separately identifiable as a principal item of capital

equipment.

(b)  The thing or structure is an integral part, but only a part, of the entire

premises and is capable of providing a useful function without regard to any

other part of the premises.

(c)    The thing or structure is a separate and distinct item of plant in itself from the

thing or structure which it serves, or

(d)  The thing is a unit of property as that expression is used in the depreciation

deduction provisions of the income tax law.

TR 97/23 at paragraph 32 provides that expenditure for repairs to property is capital expenditure if any of the following subparagraphs applies. It is considered that your situation is covered by subparagraph (b) which states:

(b) The expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety. The application of this distinction depends very much on what, in the circumstances of the case, is properly considered to be the relevant entirety.

The tests used by the courts and tribunals or suggested by commentators to identify an entirety - as distinct from a subsidiary part - include one or more of the following:

· is the property (e.g., a chimney) physically, commercially and functionally an inseparable part of an entirety (e.g., a factory)?: Samuel Jones & Co (Devondale) Ltd v. Commissioners of Inland Revenue (1951) 32 TC 513.

· is the property (e.g., a slipway) separately identifiable as a principal item of capital equipment?: Lindsay's case.

· is the thing or structure (e.g., a timber staircase) an integral part, but only a part, of the entire premises and is it capable of providing a useful function without regard to any other part of the premises?: Case W68 89 ATC 613; AAT Case 5232 (1989) 20 ATR 3796.

· is the thing or structure (e.g., meters and pumping plant) a separate and distinct item of plant in itself from the thing or structure (e.g., a light and power station) to which it supplied something (e.g., electric light and power) or an integral part of some larger item of plant?: Case 36 (1949) 15 TBRD (OS) 287.

· is the property a 'unit of property' as that expression is used in the depreciation provisions of the income tax law, bearing in mind that, to be such a 'unit', the thing or structure must be 'functionally separate and independent'?: Ready Mixed Concrete (Victoria) Pty Ltd v. FC of T (1969) 118 CLR 177; (1969) 15 ATD 215.

A leading case for determining deductibility where work is undertaken on substantially the whole of the subject matter is Lindsay v. FC of T (1960) 106 CLR 197; 12 ATD 505 (Lindsay's case), in which the High Court (Kitto J) held that expenditure incurred to renew a slipway was a renewal of an entirety and not a deductible repair. His Honour said at 106 CLR 383; 12 ATD 200:

If the work done in respect of the slipway is correctly described as repairs, it cannot, I think, on the facts of this case, be of a capital nature. The problem is to characterize the expenditure according to the familiar distinction between repair, in the sense of restoration by renewal or replacement of subsidiary parts of a whole, and renewal in the sense of reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole of the subject matter under discussion: per Buckley L.J., in Lurcott v. Wakely & Wheeler ; Rhodesia Railways v. Collector of Income Tax, Bechuanaland .

Also Case L57 (1960) 11 TBRD 365; CTBR (N.S.) case 878 (Case L57) involved a situation where a boiler was connected by a short brick tunnel to a smoke stack. The boiler, its brick foundations and the tunnel were replaced, but not the smoke stack and its brick base. The cost of the boiler made up about 80% of the replacement cost of the boiler and smoke stack.

The taxpayer argued that the boiler was part of a larger entirety, that is, the boiler and smoke stack, and hence the cost of the replacement boiler was a repair. The majority of the Board of Review held that the boiler and smoke stack did form a whole unit, but as everything had been replaced except the smoke stack there had been a renewal of a substantial part of the entirety. Therefore the cost of the replacement boiler was not a repair. The other member (Mr N. Dempsey) considered that the boiler itself was a separate entity and as it had been fully renewed the cost of the boiler was also not a repair. The fact that the boiler and smoke stack were separated by a brick tunnel was sufficient for him to conclude that these items should be treated separately and did not form part of one entirety.

In your situation, it is accepted that the walkway and landings form an entirety. However the walkway forms a substantial part of this whole, and as everything in the walkway had been replaced it is considered that there has been a renewal of a substantial part of the entirety and that the principles in Lindsay's case and Case L57 apply.

Therefore, you are not entitled to a deduction for repairs for the work done to the jetty.

Capital works deduction

The work done to the jetty of your rental property is considered capital in nature and not deductible as a repair.

Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works including building and structural improvements where a residential property is used for income producing purposes. This deduction is referred to as a capital works deduction.

The deduction is available on the cost of construction and would include work done to the jetty.

 In your case you have incurred construction expenditure on the renovation of the jetty which occurred after 15 September 1987 and accordingly you would be able to claim a capital works deduction of 2.5% per year.

It should also be noted that expenses of a capital nature may form part of the cost base of the property for capital gains tax purposes, but not generally to the extent that capital works deductions have been or can be claimed for them.