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Ruling

Subject: Rental property expenses

Question 1

Are you entitled to a deduction for the cost of replacing the roof to your rental property?

Answer

Yes

Question 2

Are you entitled to a deduction for the following work carried out to your rental property?

§ electrical repairs to bedrooms, hallway, bathroom and kitchen

§ labour, cleaning, miscellaneous repairs and driveway

§ plumbing repairs and replacement of damaged bath, toilets and tiles

§ plastering and painting of walls, ceiling, windows

§ removal of unsafe chimney

§ general repairs, maintenance, freight and cleaning costs

Answer

Yes

Question 3

Are you entitled to a capital works deduction for the following work undertaken to your rental property?

§ fire resistant wall

§ construction of new deck and handrail

Answer

Yes

Question 4

Are you entitled to a deduction for costs of consumables such as tea, coffee and sugar for your holiday accommodation?

Answer

Yes

Question 5

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

§ linen, crockery, cutlery, curtains, washing machines, bathroom heater and kitchen tap mixers.

Answer

Yes

Question 6

Are you entitled to a deduction for the following fees and charges?

§ surveyor fees, building inspections, development application for change of use to strata title and holiday accommodation

§ waste water design

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2009

Year ended 30 June 2010

The scheme commences on:

1 July 2008

Relevant facts and circumstances

You jointly own a holiday rental property consisting of two units.

The property is several years old and has been continually rented since purchase.

Your tenants at the time were relocated to another rental unit you own as the roof developed major leaking.

The roof was assessed unrepairable. You were required to replace the entire roof.

The leaking roof caused damage to the ceiling, carpets and flooring in the lounge room, bedrooms and kitchen walls.

The bathroom pipes and the old toilets were leaking and the walls were in a bad state and required replacing. Extensive plumbing and electrical repairs were carried out.

You carried out major works to have the unit returned to liveable and commercial standard befitting holiday accommodation in a popular tourist destination.

The following work had been undertaken in replacing with similar or modern version:

§ reroofing of the entire rental property

§ repairs to the ceiling

§ replacing of cracked shower base and mirrors

§ replacing of leaking and damaged toilets /sinks

§ replacing damaged tiles, cement sheets and plastering of walls

§ painting of ceilings, walls and windows

§ electrical work to bathroom, hallway and bedrooms

You have incurred costs for work undertaken to meet registration of your rental property as holiday accommodation such as general repairs, maintenance, freight, cleaning costs and purchase of linen, crockery, cutlery, curtains, washing machines, bathroom heater and kitchen tap mixers.

You also incurred costs to remove an unsafe chimney when replacing the roof.

You have converted your holiday rental property to registered holiday accommodation and incurred the following expenses:

§ building inspections

§ change of use application to strata title and holiday accommodation

§ building surveyor fees

§ waste water design

§ installation of a fire resistant wall to meet Occupational Health & Safety (OH&S) requirements.

§ construction of a new deck and hand rail as part of the planning requirements for strata title

You have provided copies of invoices and receipts for all work undertaken.

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 Division 43

Income Tax Assessment Act 1997 Section 43-10

Reasons for decision

Summary

You are not entitled to a full deduction for the work completed on your investment property.

Work to replace the roof to your investment property restores the efficiency of function of the roof and does not provide any substantial improvement is considered repairs.

Additionally, the works you have undertaken to restore the property to its original state due to the leaking of the roof are considered to be repairs and are deductible.

However, the fire resistant wall and construction of new deck and handrail is considered capital expenditure and you are entitled to a deduction for capital works.

The purchases of consumables as part of the setting up of your holiday accommodation are deductible as they are incurred whilst gaining or producing income.

You are not entitled to a deduction for the purchase of such items as linen, crockery, cutlery, curtains, washing machines, bathroom heater and kitchen tap mixers as they are depreciating assets for which you can claim a deduction for the decline in value.

You are not entitled to an immediate deduction for the cost of fees and charges for building inspections, application for change of use to strata title and registration of holiday accommodation, surveyor's fees and waste water design. However, the costs form part of the cost base of your investment property for capital gains tax purposes.

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 indicates 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.

Replacement of a subsidiary part or an entirety

 TR 97/23 at paragraph 38 considers that a 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 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.

According to paragraph 39 of the TR 97/23, property is more likely to be a 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.

In the case of W Thomas & Co Pty Ltd v. FC of T (1965) 14 ATD 78; (1965) 115 CLR 58, 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.

Repair or improvement

Paragraph 45 of TR 97/23 distinguishes between a 'repair' and an 'improvement' to property which one needs to consider the effect that the work done on the property has on its efficiency of function.

If the work entails the replacement or restoration of some defective, damaged or deteriorated part of the property, one does not focus on the effect the work has on the efficiency of function of the part. That is not determinative of whether the property is repaired or improved. It is a relevant factor to take into account, however, in considering the effect of the work on the property's efficiency of function. It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property.

Initial repair

If work is carried out to remedy defects, damage or deterioration that existed at the date of acquisition it is considered an initial repair and any expenditure incurred is considered capital in nature. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred.

Application to your circumstances

Roof replacement

The expenses that you incurred to replace the roof were to restore the property to its original state and function. You have not renewed or reconstructed an entirety and is not an initial repair.

As a result you have incurred expenses to restore your property to a rentable state. The replacing of the roof is not considered to be capital in nature. Therefore, you are entitled to a deduction for these repairs under section 25-10 of the ITAA 1997.

Other repairs

Due to the leaking of the roof you were required to undertake the following work to return your investment property to its original state using similar materials:

§ electrical repairs to bedrooms, hallway, bathroom and kitchen

§ labour, cleaning, miscellaneous repairs and driveway

§ plumbing repairs and replacement of damaged bath, toilets and tiles

§ plastering and painting of damaged walls, ceiling, windows

§ general repairs, maintenance, freight and cleaning costs

§ removal of unsafe chimney

The work carried out does not result in a greater efficiency of function and is therefore not an improvement and is not a renewal or construction of an entirety. The work undertaken was to restore the property to its previous condition.

Accordingly, the costs are not capital in nature and are deductible under section 25-10 of the ITAA 1997.

Capital works

Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes.

The rate of deduction for capital works for a residential rental property is 2.5% of construction expenditure over 40 years.

In your case, you were required to construct a fire resistant wall between the adjoining units as part of OH&S requirements. You also constructed a new deck and hand rail to the property.

The work carried out to install a fire resistant wall and construct a new deck and handrail is considered to be an improvement and is not deductible under section 25-10 of the ITAA 1997.

However, the fire resistant wall and new deck and hand rail are capital expenses. Thus you are entitled to a deduction for capital works under section 43-10 of the ITAA 1997.

Decline in value

The purchase of linen, crockery, cutlery, curtains, washing machines, bathroom heater and kitchen mixers are capital in nature and not deductible as a repair under section 25-10 of the ITAA 1997.

However, a deduction is allowable for these costs under section 40-25 of the ITAA 1997 as the purchasing of linen, crockery, cutlery, curtains, washing machines, bathroom heater and kitchen mixers are depreciating assets within the definition in section 40-30 of the ITAA 1997. They have a limited effective life and can reasonably be expected to decline in value over the time they are used in the rental property.

Consumables

Costs of purchasing consumables that are provided as part of setting up your units for your holiday accommodation are a deductible expense under section 8-1 of the ITAA 1997. These costs are incurred whilst gaining or producing assessable income.

Fees and charges

You incurred costs for building surveyors, council inspections, change of use application to holiday accommodation and strata title and waste water design to convert your rental holiday units to holiday accommodation.

As these costs are capital outlays as part of changing your rental property to strata title for holiday accommodation, they are not allowable deductions under section 8-1 of the ITAA 1997. However, these costs form part of the cost base of your investment property for capital gains tax purposes and are used to calculate the capital gain or loss arising on disposal of the property.