Edited version of private ruling

Authorisation Number: 1011769092303

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Ruling

Subject: Rental property - expenses

Question 1

Is the special levy payment fully deductible when your apartment is rented out?

Answer

No.

Question 2

Can you claim a 2.5% capital works deduction for the period when your apartment is rented out?

Answer

Yes, if the construction costs have been charged to the special purpose fund.

This ruling applies for the following periods:

Year ending 30 June 2011

Year ending 30 June 2012

The scheme commences on:

1 July 2010

Relevant facts and circumstances

You purchased an apartment, and since this time have lived in it as your primary residence.

The block of apartments is old and is in constant need of repair.

Six months after purchasing the apartment, an engineering firm produced a report on the work required on your apartment building.

A tender process was later held and various quotes for the work acquired. Each of the quotes were for more than $300,000.

In relation to this work, you have been issued a special levy by the body corporate.

You want to rent your apartment, for six months.

You intend to pay off part of the levy whilst renting your apartment out so that you can claim a tax deduction.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1,
Income Tax Assessment Act 1997 Section 25-10,
Income Tax Assessment Act 1997 Section 43-10 and
Income Tax Assessment Act 1997 Section 43-25.

Reasons for decision

Summary

The costs associated with the special levy do not qualify for an outright deduction as they are considered to be capital in nature.

However, if the construction costs have been charged to the body corporate special purpose fund and you rent the apartment for the purposes of producing assessable income, then you will be entitled to a 2.5% capital works deduction.

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 to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature.

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 word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. Paragraphs 13 -16 of TR 97/23 specifically deals with the ordinary meaning of repairs. Works can fairly be described as repairs if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time (paragraph 15 of TR 97/23).

There are several issues which would exclude expenditure from being considered to be incurred as a repair. These are where:

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

· 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.

A repair after acquisition of property is an 'initial repair' if the repair was due when the property was acquired, in the sense that there was a need for the repair to restore or maintain the property's efficiency of function, rather than repairing ordinary wear and tear occurring while the item was owned and used by the taxpayer for income producing purposes. In other words, the property was neither in good order when it was acquired nor suitable for use for income purposes in the way intended.

Taxation Ruling TR 97/23 at paragraph 59, confirms that expenditure incurred on an initial repair is a capital expenditure and is, therefore, not deductible under section 25-10 of the ITAA 1997. This paragraph also states that the cost of effecting initial repairs is still not allowable even if some income has been earned before the repair expenditure is incurred. In other words, the character of initial repairs is not altered because income is derived from the property before the expenses are incurred on the initial repairs.

In your case you have lived in the apartment since you purchased it. Although the special levy was issued 6-12 months after you initially purchased the property, you have stated that the block of apartments is old and is constantly in need of repair, therefore it can be assumed that these repairs were due at the time you acquired the property.

Also, as you have not been using the property for income producing purposes during this time, when the apartment does become available for rent the special levy costs would be considered an initial repair to the property. Therefore, as initial repairs are considered to be capital in nature a deduction for the special levy is not allowed under section 8-1 or 25-10 of the ITAA 1997.

Capital works deductions

Section 43-10 of the ITAA 1997 provides an income tax deduction for capital works attributable to a construction expenditure area that is owned or leased by the taxpayer and used during the income year for the purposes of producing assessable income.

Deductions based on construction expenditure apply to capital works such as:

· a building or an extension - for example, adding a room, garage, patio or pergola

· alterations - such as removing or adding an internal wall, or

· structural improvements to the property - for example, adding a gazebo, carport, sealed driveway, retaining wall or fence.

Section 43-25 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 spread over a period of 40 years at a rate of 2.5% per annum.

However, as per the rental property guide 2010, a capital works deduction is not allowed until the construction is complete. This guide also states that for a special levy imposed by a body corporate, you can only claim the costs of capital improvements or repairs of a capital nature once the costs have been charged to the special purpose fund.

Example: Apportionment of a capital works deduction

The owner of a unit was issued with a special levy, from the body corporate, for repairs to the block of apartments for a sum of $18,000. The constructions were complete and the costs were charged to the special purpose fund in February 2011. The unit was then rented for six months from 1 April until 30 September 2011; however both before and after this period the owner used the unit as their primary residence.

As the unit has not been rented for the whole financial year, only a portion of the special levy for the capital works is allowed as a deduction. The apportionment of a capital works deduction is worked out as follows:

In the 2010-11 year of income, as the apartment was rented out for 91 days, the owner is entitled to a $113 capital works deduction:

In the 2011-12 year of income, as the apartment was rented out for 92 days, the owner is entitled to a $114 capital works deduction:

In your case, you intend to rent your apartment for a period of six months; however both before and after this period you will be living in your apartment. As previously stated, a capital works deduction is only allowed for the period of time that your apartment is rented or available for rent.

Therefore, if the construction costs have been charged to the special purpose fund and you rent the apartment for the purposes of producing assessable income, then a 2.5% capital works deduction for the special levy costs is allowed under section 43-10 of the ITAA 1997.