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Ruling

Subject: Rental property expenses

Question 1:

Can you claim your share of an immediate deduction for some of the work done to your rental property?

Answer:

Yes.

Question 2:

Can you claim your share of a capital works deduction for some of the work done to your rental property?

Answer:

Yes.

Question 3:

Can you claim your share of a deduction for decline in value of some of the items replaced in your rental property?

Answer:

Yes.

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You have owned a joint share of a rental property for some time.

The property is a unit which is rented to a relative at the market rate for similar units in the area.

The property is not managed by a real estate agent.

You identified some termite damage to the property late in 2010.

A further termite inspection carried out in 2011 identified more extensive damage than was first thought.

At the time of this inspection, the property was between tenants, and was unfurnished.

Following damage to the property by termites, you repaired or replaced parts of the building and fittings.

The rooms which needed work done to them were the kitchen, bathroom and laundry.

The cabinetware of the laundry and bathroom suite was replaced.

Some floorboards which were affected were replaced, and the fixed vinyl floor covering in the kitchen was replaced.

Details of the work which was carried out:

· the replacement of kitchen, bathroom and laundry cabinets, skirting boards, architraves and bathroom door, including reconnections to plumbing and electrical appliances

· replacing of the blinds,

· replacing kitchen sink mixer tap and sink,

· replacing laundry/bathroom suite, mixer tap and miscellaneous fittings,

· replacing fixed vinyl floorcovering,

· replacing a washing machine,

· replacing a clothes dryer,

· replacing an oven,

· replacing a ceramic electric cooktop,

· replacing a slide out cooker hood and fan,

· replacing a dishwasher,

· replacing a mixer track for basin and shower,

· replacing a basin, waste plug, towel rails and metal toilet roll holder,

· repainting the kitchen, bathroom, bedrooms one & two, lounge, and dining room,

· replacing a built in wardrobe,

· an inspection for termite activity.

The termite inspection done in March 2011 provided details of the termite damage and recommendations about what work was required.

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 43-10

Income Tax Assessment Act 1997 Subsection 40-30(1)

Income Tax Assessment Act 1997 Subsection 40-80(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 a rental property. 

To be eligible to claim such an expense you must be holding the property for the purpose of gaining or producing assessable income, and the expenses must not be capital in nature.

Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.  

You will still be considered to hold a rental property for income purposes at the time of the repair even if it is vacant at that time if you will rent out the property again when the repairs are complete.

The meaning of repairs

The term 'repairs' is not defined in section 25-10 of the ITAA 1997. Therefore, it is necessary to look at its ordinary meaning. Paragraph 13 of Taxation Ruling TR 97/23 states the following: 

· The word 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property. 

At paragraph 44, the ruling goes on to state: 

· In the case of a 'repair', broadly speaking, the work restores the efficiency of function of the property without changing its character... 

Repair is distinct from renewal or replacement

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

What is an entirety?

Determining what is an entirety is a question of fact in each case. According to 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

of 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. 

Improvement or repair

When work is done to restore or 'fix' a damaged item, we need to determine if the work undertaken is a 'repair' or an 'improvement'. Repairs generally restore the item to its former function and efficiency whereas improvements increase an item's functionality and/or efficiency.  

A repair may increase the items efficiency slightly and still be classed as a repair. However, where the item's function or efficiency is improved substantially or the work changes the function of the item, the work is considered to be an improvement and capital in nature. 

Application of the above to your situation

You had to carry out work to your rental property due to termite damage. The work included replacement of skirting boards, architraves and bathroom door, including reconnection to plumbing and electrical appliances. The interior of the kitchen, bathroom, two bedrooms, lounge and dining room were repainted. You replaced one built-in wardrobe and had a termite inspection carried out.

You replaced damaged floorboards.

Paragraph 88 of TR 97/23 states that a repair involves a restoration of something without changing its character. The significant factor is the restoration of efficiency rather than exact repetition of form or material. For example, in Case 51 (1960) 9 CTBR (NS) 328, it was held that the replacement of a galvanised iron roof with concrete roof tiles was a repair as it did little more than meet a need for restoration. The material in question was designed to perform substantially the same function as that which it replaced.

The works listed above do no more than restore the property to its original condition. They do not materially alter the character or functionality of the rental property, and will restore the existing functionality without changing the original character. The works listed above are repairs. Accordingly, the expenditure incurred is deductible under section 25-10 of the ITAA 1997.

The termite inspection was undertaken subsequent to the remedial work undertaken to rectify the original termite damage to the property and as such may be included in other rental expenses.

Replacement of kitchen, laundry and bathroom cabinets and vinyl kitchen floor covering

Section 25-10 of the ITAA 1997 allows a deduction for expenditure on repairs to income producing premises and depreciating assets provided the expenditure is not capital in nature.

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, or  

· the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or  

· the work is an initial repair.

Example 4 from TR 97/23 illustrates the distinction between repair and either renewal or reconstruction, and what constitutes the 'entirety':

Mr Fernier and Mr Agricola are neighbouring farmers affected by a severe bushfire. Mr Fernier restores his existing fence to good condition by mending it and replacing damaged sections, e.g., the fence on the northern boundary. Mr Agricola replaces the entire fencing surrounding his property.

Mr Fernier is entitled to claim a deduction for the cost of repairing his fencing under section 25-10. The entirety is the total fencing so replacing the fences on the northern boundary is a replacement of a subsidiary part of the whole fencing.

However, Mr Agricola's expenditure is not deductible under section 25-10 because the whole fencing was replaced, making it a reconstruction of the entirety. The total fencing is not a subsidiary part of the rural property or of anything else. To replace entire fencing with new fencing is to replace one capital asset with another capital asset. The cost is therefore of a capital nature.

The kitchen, laundry and bathroom cabinets are separately identifiable items and are each fixed to the premises and intended to remain in place for a substantial period of time. The kitchen sink mixer tap and sink, mixer track for basin and shower, towel rails and metal toilet roll holder also meet these criteria, and so your replacement of these kitchen, laundry and bathroom items is capital in nature.

The vinyl kitchen floor covering was fixed to the floor, and intended to remain in place. As such, it formed part of the premises and expenditure falls under capital works.

Section 43-10 of the ITAA 1997 provides a deduction for capital expenditure on capital works used to produce assessable income. Capital works include:

· a building;

· an extension, alteration or improvement to a building; and

· structural improvements other than those referred to in (2)

The relevant rate allowed for your capital works deduction is 2.5% per annum.

Please note that in working out the capital gain or loss when you dispose of the property, you will need to reduce the cost base by the amount of the capital works deduction you were entitled to claim in respect of the above capital works.

Decline in value

Section 40-25 of the ITAA 1997 allows you to deduct from your assessable income an amount equal to the decline in value of a depreciating asset to the extent that it is used to produce assessable income or installed ready for use for that purpose.

A depreciating asset is an asset that has a limited effective life and can be expected to decline in value over the time it is used (subsection 40-30(1) of the ITAA 1997).

Subsection 40-80(2) of the ITAA 1997 provides that the decline in value of a depreciating asset will be the cost of the asset if the cost of the asset does not exceed $300 and the asset is used predominantly for the production of assessable income.

Depreciating assets

The following items are depreciating assets.

· Washing machine

· Clothes dryer

· Oven

· Ceramic electric cooktop

· Slide out cooker hood and fan

· Waste plug

· Dishwasher

· Mixer track for basin and shower,

· Mixer tap and miscellaneous fittings

· Blinds

Therefore, a deduction is allowable for your share of the decline in value of these items over their effective life. Taxation Ruling TR 2011/2 states the effective life of each of these items.