Edited version of private ruling

Authorisation Number: 1011794286548

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Ruling

Subject: Rental property expense deductibility

Questions and answers:

1. Are you entitled to an immediate deduction in the 2010 -2011 financial year for the cost of repairs for water damage carried out on your rental property?

Specifically:

· The removal and replacement of trimmings,

· Re sheeting plasterboard,

· Timber framing,

· Re hang doors and replace door furniture,

· Installation of lamipanel,

· Re wire where applicable,

· Repair the hot water system,

· Exhaust fan repaired,

· Plasterboard, firecheck, villaboard, glue, screws, plaster, fire mastic,

· Fix sheets,

· Plaster joins,

· Fit metal angles, and

· Waterproof walls and floors to bathroom.

Yes.

2. Are you entitled to a decline in value deduction in the 2010 -2011 financial year for the cost of repairs for water damage carried out on your rental property?

Specifically:

· Range hood,

· Air-conditioning unit, and

· Ceiling fans.

Yes.

3. Are you entitled to a capital works deduction in the 2010 -2011 financial year for the cost of repairs for water damage carried out on your rental property?

Specifically:

· Flooring system,

· Power and TV points,

· New kitchen,

· New vanity in bathroom, and

· Mirrored shaving cabinet in bathroom.

Yes.

4. Are you entitled to a capital works deduction in the 2010 -2011 financial year for the cost of repairs for water damage carried out on your rental property?

Specifically:

· General carpentry demolition,

· demolition of kitchen,

· vanity in ensuite, and

· mirrored shaving cabinet in ensuite.

No.

This ruling applies for the following periods:

Year ended 30 June 2011.

The scheme commenced on:

1 July 2010.

Relevant facts:

You own a share in a rental property.

You are a tenant in common with another person.

You obtain rental income from one bedroom which is rented to a student or family member.

At the time of flooding the tenant was a family member.

The room is rented at a market rate of $XX per week.

The entire property rental market rate is $XX per week.

The property was available to rent for the entire of the 2010 - 2011 year and you intend to tenant it again.

The rental property received water damage as a result of floods during 2011.

The damage was X metres of water throughout the entire property.

All contents were removed prior to flooding.

No insurance payment will be received for the repairs.

The property was in good condition prior to damage.

Expenditure to repair damage to the property will be partially paid by the state government relief scheme totalling $XX.

The kitchen and 1 of the 2 bathrooms are shared with the tenant.

All tiles are being replaced in the bathroom.

All tiles are being replaced throughout the property.

Previously carpeted rooms (bedrooms and living areas) are to be replaced with tiles throughout.

Bathroom tiles are being replaced with similar tiles to those used previously.

Kitchen repairs include the replacement of cupboards and drawers using kits rather than custom built as per the previous kitchen.

Sink, dishwasher, oven, stove top and bench top are being reinstalled and not replaced.

The air-conditioning unit is being replaced in the main living area with other units being replaced with ceiling fans.

Assumptions:

N/A

Relevant legislative provisions:

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-10.

Income Tax Assessment Act 1997 Subsection 25-10(2).

Income Tax Assessment Act 1997 Subsection 25-10(3).

Income Tax Assessment Act 1997 Section 43-10.

Income Tax Assessment Act 1997 Section 43-70(2).

Reasons for decision

Expenses allowable for an Immediate deduction

Repair expenditure

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.

Repairs are not specifically defined in ITAA 1997, but are generally recognised by their ordinary meaning as the restoration or renewal of defective parts of a whole.

Capital expenditure

Where work will go beyond what is a 'repair' in terms of section 25-10 of the ITAA 1997, any expenditure for the work is not immediately deductible.

Subsection 25-10(3) of the ITAA 1997 does not allow a deduction where there is a renewal or replacement of an entirety or an improvement (and or an initial repair, not relevant in your instance) as this type of expenditure is capital in nature.

Whether expenditure incurred relates to the replacement of part or an entirety, is a question of fact and degree. It should be considered whether the item is separate or part of a larger item.

For an example of items considered to be an entirety in Taxation Ruling TR 97/23 include;

· Principal items of capital equipment,

· an item capable of providing a useful function without regard to any other part of the premises,

· the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves, and

· the thing or structure is a 'unit of property'.

Items considered to be a part include;

· 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.

Expenditure incurred may be an improvement if the work has done more than restore to normal or former condition, that is it has added something to the item. This may be by changing the character or increasing efficiency of function of the item.

For example an improvement may extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.

The determinative test in Taxation Ruling TR 97/23 (para 46) is whether the replacement or restoration of a defect has changed the efficiency of the whole. For example it may not be an improvement to increase the efficiency of a part, if the entire property's efficiency has not changed.

The use of new or different materials to the original can, but is not always considered an improvement. They may be an allowable repair where the different materials are incidental to the repair.

Expenses allowable for a deduction over a number of years

Although an expense may be capital in nature and as such not allowable as an immediate deduction. A deduction or partial deduction may be available over several years.

Decline in value deduction

Section 40-25 of the ITAA 1997 allows a taxpayer to a deduction for the decline in value of a depreciating asset. Where you hold a depreciating asset (separate asset in its own right) used solely or partially for income producing purposes, you can deduct an amount equal to the decline in value/depreciation for an income year.

A depreciating asset is an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used. Generally, a taxpayer holds an asset if the taxpayer is the legal owner of the asset.

The decline in value of an asset is calculated by spreading the cost of the asset over its effective life. Effective life is either self-assessed or determined by the Commissioner. Any references to specific Effective lives can be found in the Rental properties guide (NAT 1729-6.2010) available online (www.ato.gov.au).

There are two methods available to calculate a decline in value deduction based on the chosen effective life;

1. Diminishing value method, or

2. Prime cost method.

Both these methods are outlined in the Rental properties guide.

Where the item is part of the setting for the rent producing activity you can not claim deprecation, but you may be allowed a capital works deduction.

Capital works deduction

Section 43-10 of the ITAA 1997 allows certain expenditure on construction to be deductible where the construction is complete. Expenditure must not have been previously included when calculating any other deductions.

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

· a building or an extension,

· alterations, or

· structural improvements to the property.

In the case of a residential rental property the deductions would be spread over a period of 25 or 40 years.

The Rental properties guide provides tables to assist edibility and calculations of the amount of an allowable capital works deduction.

Apportionment of rental expenses

Private use

A deduction is only allowable to the extent that it is used for income producing purposes. Where it is held partly for income producing purposes subsection 25-10(2) of the ITAA 1997 allows a deduction which is reasonable in the circumstances.

It is your intention to rent out only one room of the property and allow a tenant shared access to kitchen, living, meals, laundry, and bathroom. As only this portion of the property relates to the earning of assessable income, you are entitled to a deduction for your share of that portion of the expenses incurred in gaining that income.

Apportionment is a question of fact and involves a determination of the proportion of the expenditure that is attributable to deductible purposes. The Commissioner believes that the method of apportionment must be fair and reasonable in all the circumstances.

A general requirement when apportioning expenditure is to assign a percentage to represent the deductible part of a composite expenditure. There is no universally accepted formula that can be applied, as long as the apportionment is reasonable in the circumstances and there is some proof of its determination.

An acceptable method to apportion the expenses is by calculating the floor area of that part of the house used for income producing purposes as a percentage of the total floor area of a property.

You will also need to apportion your expenses if your property is available for rent for only part of the year.

Ownership

Taxation Ruling TR 93/32 outlines that ownership based on legal title to the property will determine the amount of income and expenses you can declare for tax purposes.

Immediate deductions

Section 25-10 of the ITAA 1997 would allow immediate deductions to cost of repairs to your ownership share of the rental property for the following items to the extent they are used for income producing purposes:

Labour and Material expenses for:

· The removal and replacement of trimmings,

· Re sheeting plasterboard,

· Timber framing,

· Re hang doors and replace door furniture, and

· Installation of lamipanel.

Electrician expenses to:

· Re wire where applicable,

· Repair the hot water system, and

· Repair exhaust fan.

Plasterer expenses for:

· Supply materials - Plasterboard, firecheck, villaboard, glue, screws, plaster, fire mastic,

· Fix sheets,

· Plaster joins, and

· Fit metal angles.

Waterproofing expenses to:

· Waterproof walls and floors to bathroom.

Decline in value deduction

The following are depreciating assets as per section 40-25 of the ITAA 1997 that you can deduct an amount equal to the decline in value for an income year using either of the methods outlined previously. You will need to apportion these expenses on a reasonable basis in each income year.

· Supply and fit range hood.

Effective life of 12 years.

· The air-conditioning unit.

See the Rental guide 2010 for specific years for effective life depending on the type of unit being installed e.g. chillers, versus air handling units.

· Ceiling fans.

Effective life of 5 years.

Capital works deduction

In your case, section 43-10 of the ITAA 1997 will enable you to have a capital works deduction for the following alterations and structural improvements to your share of the rental property, once complete.

· Labour and materials for fit out of the flooring system,

· Supply and installation of power points and TV point (capital works deduction as hardwired and as such become part of the structure of the property. Apportionment recommendation to consider power points in tenants room and 50% of those in shared areas).

· Installation of new cupboards and drawers,

· New vanity to bathroom, and

· Mirrored shaving cabinet to bathroom.

No deduction allowable

The following events/items do not qualify for an immediate deduction as a repair, as a decline in value deduction or capital works deduction.

· General carpentry demolition,

· demolition of kitchen,

· vanity in ensuite, and

· mirrored shaving cabinet in ensuite.

Demolition is specifically excluded from the definition of construction expenditure in respect of capital works, subsection 43-70(2) of the ITAA 1997.

You have indicated that the ensuite will only be used for private purposes, and as such as per section 8-1 of the ITAA 1997 any items/assets to be installed within are not being used for income producing purposes.

Apportionment

The expenses which qualify for an immediate deduction, decline in value deduction, or capital works deduction need to be apportioned to an amount which reflects their income producing use and your ownership interest. You will need to make a reasonable apportionment in each income year.

As previously discussed an acceptable method to apportion the expenses is by calculating the floor area of that part of the house used for income producing purposes as a percentage of the total floor area.

Any final amount claimed as a deduction should not include any amounts to be paid by the state government relief scheme totalling $XX.

We have enclosed the Tax Office guide Rental properties 2010. Further information on rental properties is available on the Tax Office web site: www.ato.gov.au.