Edited version of private ruling

Authorisation Number: 1011845589878

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Ruling

Subject: Rental property repairs

Question 1

Are you entitled to an immediate deduction for expenses incurred in replacing a fence at your rental property?

Answer

No.

Question 2

Are you entitled to a capital works deduction for the work performed on the fence at your rental property?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

You own a rental property.

You bought the property approximately 1X years ago and immediately made it a rental property.

The property has a fence along one of the boundaries.

The fence was in a poor condition and the entire fence was replaced.

You replaced the fence because you had received complaints from tenants and neighbours and did not want to risk litigation if someone was injured due to the dilapidated condition of the fence.

The fence was replaced with a similar fence using similar materials.

There are no fences on the other boundaries.

When the property was acquired, the fence was in a similar poor condition to what it was prior to its replacement.

Reasons for decision

Question 1

Summary

You are not entitled to a deduction for the cost of replacing the fence as it is a replacement of an entirety and an initial repair.

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, or relate to the earning of exempt income.

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. In W Thomas & Co Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710, 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 provides that expenditure for repairs to property is of a capital nature 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'

· the work is an initial repair.

Renewal or reconstruction of the entirety

In determining what is the entirety is a question of fact in each case. Property is more likely to be an entirety if:

· the property is separately identifiable as a principal item of capital equipment

· 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

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

· the thing or structure is a unit of property as that expression is used in the depreciation deduction provisions of the income tax law.

Property is more likely to be subsidiary part rather than an entirety if:

· it is an integral part of some larger item of plant

· the property is physically, commercially and functionally an inseparable part of something else.

Initial repairs

Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not deductible under section 25-10 of the ITAA 1997.

The expression 'initial repair' is discussed in TR 97/23. It refers to a repair by a taxpayer that remedies some defect in property or makes good damage to, or deterioration of, property being a defect, damage or deterioration:

· existing at the time of acquisition of the property

· not arising from the operations of the taxpayer who incurs the expenditure.

Application to your circumstances

In your case the fence is a separate identifiable capital item with its own function. As the entire fence was replaced, the work carried out is considered to be a renewal and reconstruction of an entirety. Furthermore as the fence was damaged at the time you purchased your rental property, the work carried out is an initial repair to remedy an existing defect in the capital asset. Therefore the reconstruction of the fence is capital expenditure and not deductible as a repair under section 25-10 of the ITAA 1997.

Additionally, as the work is capital in nature it is not deductible under section 8-1 of the ITAA 1997.

Question 2

Summary

You are entitled to a 2.5% capital works deduction for the cost of replacing the fence as the work performed is considered to be capital works.

Detailed reasoning

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

The deduction is available on the cost of constructing structural improvements or extensions, alterations or improvements to structural improvements if the construction started after 26 February 1992 (subsection 43-20(2) of the ITAA 1997).

For structural improvements, the annual capital works deduction allowable is 2.5% of the construction expenditure for a period of 40 years. Construction expenditure is the actual cost of constructing the capital works (section 43-25 of the ITAA 1997).

In your case, the works undertaken to your rental property to replace the fence are considered to be capital works for the purposes of Division 43 of the ITAA 1997. As such, you are entitled to claim an annual capital works deduction at a rate of 2.5% of the construction costs.  This deduction is available only while the property is being rented or available for rent, up to a maximum period of 40 years.