Edited version of private ruling

Authorisation Number: 1011827304708

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Ruling

Subject: Deduction-repairs

Question 1

Are you entitled to claim a deduction for your share (as per your legal interest) for the following work undertaken to your rental property?

· treatment to part of the foundation

· the water traps and inspection plate

· the traffic management, road permits, CCTV footage and the reports for site and soil testing costs.

Answer: Yes.

Question 2

Are you entitled to claim a deduction for your share (as per your legal interest) for the cost to relocate your tenants to temporary accommodation while the work was undertaken to your rental property?

Answer: Yes.

This ruling applies for the following periods:

Year ended 30 June 2010
Year ending 30 June 2011

The scheme commenced on:

1 July 2009

Relevant facts

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

· a private ruling application

· a site investigation report

· a letter from a local government entity

· a property sewage plan

· a quote

· a site diagram of the property

· a number of tax invoices.

You and your spouse purchased a property.

A pre-inspection report indicates there was no cracking to the walls of the property.

The sewer and drainage systems for the property functioned normally.

You and your spouse own the property.

The property has been available for rent for a few years.

The foundations of the dwelling are located on a number of boundaries of the block of land. Due to the design of the property the sewer system runs under a roadway into the sewer main.

A letter was sent to local government authority noting your concerns of water laying on the roadway.

The local authority had undertaken work to lift and re-lay the road surface to improve surface drainage.

The tenant observed that during the course of the work undertaken by the local authority to the roadway, the water trap was damaged. The tenant requested the damage to the trap to be repaired; however, the repair work was not undertaken.

The tenant first detected cracking to the property a number of rooms of the property.

You were notified by the tenant of the damage to the dwelling.

You engaged a contractor to inspect the property and to provide a quote to rectify the damage caused by the subsiding of the part of footing of the property.

You sent a letter to the local government authority expressing concern regarding the damage to your property.

You engaged an engineering company to undertake a structural assessment of the property. They found that as a result of the broken water trap excessive moisture in the subsoil caused a heave resulting in the excessive cracking in part of the property.

Remedial work was undertaken to underpin part of the foundations of the property.

To undertake the testing and underpinning of the foundation to the dwelling you were required to block the roadway off to drill injection holes beneath the dwelling's foundation to carryout testing of the soil and the injection of the materials.

During the CCTV search of the sewer pipes a blockage was discovered in the water trap located in the roadway.

The water traps were made of clay piping.

The water traps were replaced with PVC piping and no modifications were undertaken to either trap.

You installed an inspection plate to allow access to the water traps to assist in clearing and inspecting for any further blockages in the future.

The installation of the inspection plate does not enhance the value of the property nor does it enhance the function of the sewer system.

You paid expenses in relation to the work undertaken.

During the process of underpinning the foundation damage was caused to the pipes under the property, the water traps and the sewer pipes from your property under the roadway to the main sewer and storm water systems.

The roadway is an asset of the local authority and the sewer pipes including the water traps, pipes are the financial responsibility of the owner of the property.

You and your spouse lodged an insurance claim with your insurer.

Your insurer has taken legal action against the local authority.

You intend to declare the insurance proceed as income in your tax return if your claim is successful.

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(3).
Income Tax Assessment Act 1997 section 20-20.
Income Tax Assessment Act 1997 subsection 20-20(2).

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.

Taxation Ruling TR 97/23 deals with the issue of deductions for repairs.

A repair involves a restoration of a thing to a condition it formerly had without changing its character. What is significant is the restoration of efficiency in function rather than the exact repetition of form and substance. Repair involves restoration by replacement or renewal of a worn-out or dilapidated part of something but not reconstruction of the whole thing, that is the entirety.

Determining what is the entirety is a question of fact in each case and often causes difficulty. In a case involving 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, etc, was a repair to the building (W Thomas & Co Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710). On the other hand, in a case involving the demolition and reconstruction of a slipway, the slipway was held to be an entirety in itself (Lindsay v. Federal Commissioner of Taxation (1960) 106 CLR 377; 12 ATD 197).

However, substantial improvements, additions, alterations, modernisations are not repairs. Some of the factors pointing to an improvement rather than a repair are whether: 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; and the expenditure reduces the likelihood of future repairs.

If an asset was in disrepair at the time of its acquisition, the cost of initial repairs to remedy those defects is of a capital nature and non-deductible because it would have be taken into account in the purchase price.

Application of the above to your situation

Foundation treatment

Your rental property has been available for a few years. The walls of the property were in good condition as no cracking in the walls or foundations were reported before you purchased the property.

Case V2 88 ATC 107; AAT Case 4012 (1988); 19 ATR 3038 concerned partial underpinning of a rental property caused by excessive drying of the subsoil. It was found that the foundations were restored to their former efficiency in function without the essential character of the foundations being altered. The repairs to the foundations were not capital in nature, as they did not change the nature and character of the building and as such were deductible as repairs.

Similarly in your case, the information you provided shows that the underpinning work that was undertaken is not a renewal or reconstruction of the entirety as only a section of the property's foundation required underpinning. The work to be completed will restore the property to it's former efficiency in function and would therefore not be considered an improvement to the property. The costs you incurred are for a repair and are not capital in nature. Therefore, you are entitled to claim your portion (as per your legal interest in the property) for the expenditure incurred in repairing part of the foundation of the property as a deduction.

Damage to the water traps and water pipes

The sewer and drainage systems for the property were functioning normally when you purchased the property. The damage to the gully trap arose as a result of the carelessness of a contractor when carrying out work to relay the road. The replacing of the water traps was a result of a blockage and the treatment following work to underpin the property. The water traps forms only a part of the sewerage system which would include the cistern and the toilet bowl. Similarly, the other water trap would only form part of the drainage system for the waste water from the sinks and baths. The water traps are not capable of providing a useful function without regard to rest of the drainage and sewage system of the property. The replacement of the water traps does not constitute the replacement of an entirety.

It is accepted that the use of PVC pipes to replace clay piping constitutes a repair as the change in material did not improve the efficiency or function of the sewer or drainage systems. The work undertaken on the sewer and drainage systems indicates the sewer and drainage systems have merely been repaired by its modern equivalent and restored the original function. While an inspection plate was installed to assist with clearing and detecting any further blockages, there are no significant advantages associated with it.

It is considered that the replacement of the water traps and the installation of the inspection plate is a repair and the cost is deductible under section 25-10 of the ITAA 1997. Similarly cost for the work to the repair broken pipes under the property is also an allowable deduction as a repair under section 25-10 of the ITAA 1997 as pipes were restored to their original condition.

The traffic management costs, road permits, CCTV footage and the reports for site and soil testing are also allowable deductions as part of the repair as these are expenses when viewed objectively where incurred to determine the extent and to rectify the damage to the property.

Accommodation expense

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent that they are incurred in gaining or producing assessable income, except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income. 

Expenses that are 'incidental and relevant' to the taxpayer's income earning activities are considered to be sufficiently connected with the derivation of assessable income and therefore will be an allowable deduction under section 8-1 of the ITAA 1997 (Ronpibon Tin NL & Tongkah Compound NL v. Federal Commissioner of Taxation (1949) 78 CLR 47; (1949) 4 AITR 236; (1949) 8 ATD 431).

Therefore, providing the expense can be objectively viewed as a necessary or natural consequence of the taxpayer's income earning activities, the expense will be 'incidental and relevant' to the income earning activities of the taxpayer.

In your case as a landlord, it is expected that you are to provide premises which are fit for occupation. However due to the extent and nature of the work you had to relocate your tenants to undertake the work to the property and as a result incurred a cost to relocate your tenants to temporary accommodation.

In these circumstances your expenditure can be viewed as a natural consequence of your income earning activities as a landlord and therefore 'incidental and relevant' to the derivation of rental income.

Accordingly, you are entitled to claim a portion (as per your legal interest in the property) for the expenditure incurred to relocate your tenants to short term accommodation under section 8-1 of the ITAA 1997.

Dividing income and expenses according to legal interest

Taxation Ruling TR 93/32 examines the taxation position of co-owners of a rental property whose activities do not amount to the carrying on of a business.

TR 93/32 states that the co-ownership of rental property is a partnership for income tax purposes but is not a partnership at general law unless the ownership amounts to the carrying on of a business. Generally, where co-ownership is a partnership for income tax purposes only, the income/loss from the rental property is derived from co-ownership of the property and not from the distribution of partnership profits/losses. Accordingly, the income/loss from the rental property must be shared according to the legal interest of the owners except in those very limited circumstances where there is sufficient evidence to establish that the equitable interest is different from the legal title.

As noted in Rental properties 2010 guide at page 4 co-owners who are not carrying on a rental property business must divide the income and expenses for the rental property in line with their legal interest in the property.

If they own the property as:

· joint tenants, they each hold an equal interest in the property

· tenants in common, they may hold unequal interests in the property, for example, one may hold a 20% interest and the other an 80% interest.

Rental income and expenses must be attributed to each co-owner according to their legal interest in the property, despite any agreement between co-owners, either oral or in writing, stating otherwise.

In your case, you have not provided evidence to establish that the equitable interest is different from the legal title. Accordingly the income and expenses must be shared according to your legal interest in the property.

Other information

Assessability of insurance proceeds

Section 20-20 of the ITAA 1997 concerns assessable recoupments. Subsection 20-20(2) of the ITAA 1997 provides that an amount you have received as recoupment of a loss or outgoing is an assessable recoupment if you received the amount by way of insurance or indemnity and the amount can be deducted as a loss or outgoing in the current or previous years and is deductible under any provision of the ITAA 1997.

The costs to undertake the repairs to the property are deductible under section 25-10 of the ITAA 1997 and if you receive an insurance payout to cover these costs, it is considered to be an assessable recoupment under subsection 20-20(2) of the ITAA 1997 and should be declared in your income tax return.