Edited version of your private ruling

Authorisation Number: 1011946190020

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Ruling

Subject: Rental deductions

Question 1

Are you entitled to an outright deduction in relation to the following?

· replacement of gyprock walls and ceiling in the downstairs area

· replacement of gyprock walls to 50cm above floor height upstairs

· restoration of the lower section of the firewall

· replacement of the timber staircase

· painting

· replacement soil

· replacement of damaged tiles

· removal, reframing and replacing sliding doors

· replacement of damaged doors

· fixing a broken window

· replacement of damaged roller door

· electrical work on the damaged switchboard, powerpoints and lights

· the portion of the demolition costs, council inspection fees, builder's profit, skip hire and your travel expenses (including meals) that relate to the above items

Answer

Yes.

Question 2

Are you entitled to a capital works deduction in relation to the following?

· kitchen cabinets

· vanities

· laundry sink unit

· toilet cisterns and seats

· floor tiles that replaced the floating timber floor

· the portion of the builder's profit that relates to the above items

Answer

Yes.

Question 3

Are you entitled to claim a balancing adjustment deduction for the following items which were destroyed?

· oven

· dishwasher

· reverse cycle air conditioner

· gas hot water system

· vertical blinds

· carpet

· motor and remotes for roller door

Answer

Yes.

Question 4

Are you entitled to claim a decline in value deduction for the following new items?

· oven

· dishwasher

· air conditioner

· gas hot water system

· vertical blinds

· motor and remotes for roller door

· carpet

Answer

Yes.

Question 5

Does the capital expenditure for the works to your rental property that do not qualify for a deduction form part of the cost base of the property for capital gains tax (CGT) purposes?

Answer

Yes.

Question 6

Are you required to reduce your claims for rental deductions due to the fact that your rental property was vacant for a period while restoration work was being carried out?

Answer

No.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

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:

· the private ruling application,

· copy of tax agent schedule,

· copy of newspaper article, and

· copies of photos of damaged property

You are the sole owner of a two story investment unit.

Your rental property was flooded part way into the second storey.

Your policies for property insurance via the body corporate and landlord's insurance did not cover flooding. You therefore paid for all the work required to be carried out on the unit to enable it to be rented again.

The works performed are as set out in the questions above and in your private ruling application.

As you reside and work in another town, you travelled to the property each weekend (several hundred kms return trip) to work on the damaged unit. Except for one weekend when there were no stairs to the upper level and you had to stay in a motel, you stayed in the unit. With no electricity or running water to the property, all meals had to be purchased during these weekends.

The property was unfit to rent for approximately three months.

Your tax agent has gone through the existing depreciation schedule and claimed the write-off value of all items that were destroyed.

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 40-25.

Income Tax Assessment Act 1997 Section 40-30.

Income Tax Assessment Act 1997 Section 40-285.

Income Tax Assessment Act 1997 Section 43-10.

Income Tax Assessment Act 1997 Section 43-20.

Reasons for decision

Summary

You are not entitled to a full deduction for the work completed on your rental property as some of the expenditure is capital in nature.

Some of the capital expenditure is in relation to new depreciating assets for which you can claim a decline in value deduction. You are entitled to a balancing adjustment deduction that takes into account the adjustable value (written down value) of the depreciating assets that were destroyed.

Other amounts of capital expenditure qualify for the 2.5% capital works deduction. The capital expenditure that does not qualify for any deduction will form part of the cost base of your property for CGT purposes.

You are entitled to rental property deductions for the period your rental property was vacant while restoration work was being carried out as it was being held for income producing purposes.

Detailed reasoning

Rental property expenses

The general deduction provision is section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) which allows a deduction for expenditure incurred in gaining or producing assessable income except where it is of a capital nature, private or domestic nature or relates to the earning of exempt income.

A deduction for expenditure incurred for repairs to property used to produce assessable income is specifically allowed under section 25-10 of the ITAA 1997. However, as with section 8-1 of the ITAA 1997, the expenses must not be capital in nature.

The renewal, replacement, or reconstruction of, the whole or substantially the whole of a thing or structure (entirety) is likely to be considered a capital expense rather than a deductible repair.

Determining what is an entirety is a question of fact in each case. According to Taxation Ruling TR 97/23, property 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 entire premises and is capable of providing a useful function without regard to any other part 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.

In the case of W Thomas & Co Pty Ltd v. FC of T (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710 which involved 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 was a repair to the building. It was held that the roof would be considered to be part of the building and the work done on the roof was a repair. This view is confirmed in TR 97/23 at paragraph 40.

Where expenditure in relation to a rental property is capital in nature and therefore not allowable as an outright deduction under sections 8-1 or 25-10 of the ITAA 1997, a deduction spread over time may be available. This may be a capital works deduction under Division 43 of the ITAA 1997 or a decline in value (depreciation) deduction under Division 40 of the ITAA 1997.

A capital works deduction is generally claimed at a rate of 2.5% over 40 years and is for construction expenditure in relation to a building.

Expenditure on plant is specifically excluded from the capital works deduction. A decline in value deduction is claimed over the effective life of a depreciating asset (including plant) used for income producing purposes. This deduction cannot be claimed where a capital works deduction for the item is allowable (subsection 40-45(2) of the ITAA 1997).

The issue of whether an item is plant is significant as it is relevant in determining whether a capital works deduction or a decline in value deduction is available. A residential rental property is almost always the setting of the landlord's rental income earning activities and not within the ordinary meaning of plant. Similarly an item that forms part of those premises is part of that setting and not within the ordinary meaning of plant.

It is a question of fact and degree as to whether an item forms part of the premises. The following are relevant matters to consider when determining that question:

· whether the item appears visually to retain a separate identity;

· the degree of permanence with which it has been attached;

· the incompleteness of the structure without it; and

· the extent to which it was intended to be permanent or whether it was likely to be replaced within a relatively short period.

Where a depreciating asset in a rental property is destroyed and no insurance proceeds are received, a balancing adjustment deduction is allowable for the asset (section 40-285 of the ITAA 1997).

With respect to capital gains tax, capital expenditure will form part of the cost base of a rental property if the purpose or the expected effect of the expenditure was to increase or preserve the property's value. However, the expenditure that is included in the cost base must be reduced by the amount that you claimed, or were entitled to claim, as a deduction (section 110-45 of the ITAA 1997).

Application of the above to your situation

Rental property deductions are allowable where a property is being held for income producing purposes. Although your rental property was vacant for a period during the 2010-11 financial year, this was because it was being restored after being damaged. The property was re-tenanted as soon as it was possible. It is accepted that during the period the property was vacant, it was still being held for income producing purposes. Therefore, you are entitled to rental property deductions in relation to this period. That is, you are entitled to rental property deductions for the full 2010-11 financial year.

Outright deduction 

It is considered that the following expenses qualify for an outright deduction as they are either repairs or meet the requirements of section 8-1 of the ITAA 1997:

· replacement of gyprock walls and ceiling in the downstairs area

· replacement of gyprock walls to 50cm above floor height upstairs

· restoration of the lower section of the firewall

· replacement of the timber staircase

· painting

· replacement soil

· replacement of damaged tiles

· removal, reframing and replacing sliding doors

· replacement of damaged doors

· fixing a broken window

· fixing the damage to the roller door when it was ripped open

· electrical work on the damaged switchboard, powerpoints and lights

· the portion of the demolition costs, council inspection fees, builder's profit, skip hire and your travel expenses (including meal expenses) that relate to the above items

Capital works deduction

The following items are separately identifiable items with their own function:

· kitchen cabinets

· vanities

· laundry sink unit

· toilet cisterns and seats

As a consequence, they are an entirety in themselves and their replacement is a renewal of the entirety. As the expenditure is capital in nature, a repairs deduction is not allowable.

Although they are separately identifiable items, they are fixtures and, therefore, a part of the building because they satisfy the 'degree of annexation' and the 'object of annexation' tests that are generally applied to determine whether there is a fixture at common law. They are not in place simply by their own weight but are fixed to the building. Also, they are installed with the intention that they shall remain there indefinitely.

The role and function of these items in relation to the income producing activities do not go beyond being part of the setting of an income producing operation when they are installed in a residential rental property. As a result, they are not plant.

The expenditure on these items is construction expenditure for which a 2.5% capital works deduction is available under Division 43 of the ITAA 1997.

Also, the cost of installing floor tiles to replace the floating timber floor is also considered to be construction expenditure that qualifies for the 2.5% capital works deduction. A repairs deduction is not available as the replacement of the floating timber floor with tiles is not considered to be a repair.

In your private ruling application you referred to 'builder's profit'. The portion of any builder's profit that relates to the items which qualify for capital works forms part of the construction expenditure for these items and is included in the calculation of the 2.5% capital works deduction.

A decline in value deduction under Division 40 of the ITAA 1997 cannot be claimed for these items as this type of deduction is not available where an item qualifies for a capital works deduction (subsection 40-45(2) of the ITAA 1997).

Depreciating assets

The following depreciating assets in your rental property were destroyed:

· oven

· dishwasher

· reverse cycle air conditioner

· gas hot water system

· vertical blinds

· carpet

· motor and remotes for roller door

You were not covered by insurance for their loss. Therefore, you are entitled to a balancing adjustment deduction for these assets which takes into account the adjustable value (that is, the remaining written down value) of the assets.

You acquired the following new items for your rental property:

· oven

· dishwasher

· air conditioner

· gas hot water system

· vertical blinds

· motor and remotes for roller door

· carpet

These items are considered to be depreciating assets and therefore, you are entitled to a deduction for their decline in value under Division 40 of the ITAA 1997.

You advised that part of the electrical work done to your property included installing the oven. The portion of the expenditure on electrical work that relates to the oven installation is included in the cost of the oven for depreciation purposes.

Other capital expenditure

You incurred some expenditure, such as skip hire and travel, which relates to all the work done to your rental property. Therefore, an apportionment is necessary.

The portion of the expenses that relate to the repairs done to your property can be claimed as part of your repairs deduction.

The portion of the expenses that is considered construction expenditure can be included in the calculation of the 2.5% capital works deduction.

The portion of the expenses that is considered capital in nature but that does not qualify for inclusion in a capital works or decline in value deduction can be included in the cost base of the property for CGT purposes.

For example, it would be expected that your travel to your rental property involved organising repairs and capital works. You will need to work out a reasonable apportionment of your travel. The portion that relates to repairs would be claimed as part of your repairs deduction. The portion that relates to organising capital works however cannot be included as part of your calculation of the 2.5% capital works deduction. This is because the cost of your travel is not construction expenditure. However, the portion of your cost that relates to organising capital works is included in the cost base of your property for CGT purposes because the purpose of this expenditure was to preserve or increase the property's value.

Other information

With your private ruling application you attached a newspaper article that advised that if you have to replace depreciating assets, such as air conditioners or ovens, because they were damaged, you can claim 100% of the replacement value at the full invoice amount.

That advice contained in the newspaper article is incorrect. As discussed further above, a balancing adjustment deduction is available with respect to the adjustable value (remaining written down value) of a depreciating asset that is destroyed and a decline in value deduction can be claimed on a new replacement asset over the life of the replacement asset. However, an immediate deduction for 100% of the cost of the replacement asset is not allowable.