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Ruling

Subject: Deductions for repairs to rental property

Question

Can any portion of the costs you incurred in resealing the roof of your rental property be claimed as a repair?

Answer:

No.

Question:

Can the costs of resealing the roof of your rental property be included in the calculation of a capital works deduction claim?

Answer:

Yes

This ruling applies for the following period

Year ended 30 June 2011

The scheme commenced on

1 July 2010

Relevant facts

You acquired a rental property in late 2009.

You did not perform a pre-purchase building inspection upon acquiring the property.

To the best of your knowledge, the property was built in the 1970s, and the previous owners acquired it in 1994.

Early in the 2010-11 financial year you received advice that the tiles of your property's roof be resealed due to deterioration.

Aside from some minor maintenance carried out in the second half of 2009, the roof has been the same since the property was built.

The contract of work to be carried out, dated shortly after the advice was received, quoted the cost of the resealing.

The work was completed in the second half of 2010.

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

Reasons for decision

Section 8-1 of the Income Tax assessment Act 1997 (ITAA 1997) provides that you may deduct from your assessable income any loss or outgoing to the extent that it is incurred in gaining or producing your assessable income, but not to the extent that it is capital, private or domestic in nature.

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.

Taxation Ruling TR 97/23 discusses the circumstances in which expenditure incurred for repairs may or may not be an allowable deduction under section 25-10 of the ITAA 1997.

The word 'repair' is not defined within the taxation legislation.  Accordingly, it takes its ordinary meaning. Works can fairly be described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time (paragraph 15 of TR 97/23).

While some works may be fairly described as repairs, the expenditure will be considered capital in nature in some situations, and therefore not deductible under section 25-10 of the ITAA 1997. Expenditure incurred for repairs to property used for income producing purposes is of a capital nature where:

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

· the extent of the work carried out represents a renewal or reconstruction of the entirety, or

· the work is an initial repair.

An improvement

An 'improvement' involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.

In your case, the resealing of your roof would not be an improvement as it was undertaken to restore its original function of keeping water from damaging the house's interior, and does not constitute more than a mere repair.

An entirety

TR 97/23 states that a thing or structure is more likely to be an entirety if it 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 ruling states that something that is part of a building, for example, a roof or wall, is just that and no more. The building itself is the entirety.

In your case, the resealing of your roof would not constitute an entirety, as it is merely restoring the function of a portion of your rental 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.

The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs

the expenditure.

It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price reflected the need for repairs. An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer's assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property acquired. Initial repair expenditure relates to the establishment of the profit yielding structure. It is capital expenditure and is not deductible under section 25-10 of the ITAA 97.

In your case, the tiles on your property's roof needed to be resealed as they had become porous over time due to age and wear and tear, letting in a considerable amount of rain. You acquired the property in late 2009 and became aware of the deterioration of the roof when the suggestion to reseal was made early in the 2010-11 financial year.

The contract of work was established early in the 2010-11 financial year, and the work was completed shortly afterwards. This work was performed less than 12 months after you acquired the property. The deterioration of the roof tiles would have existed prior to your purchasing the property.

As the work done was to repair a defect existing when the property was acquired, the repair is considered an initial repair and therefore, capital in nature. As a result, you are not entitled to a deduction for the cost of resealing the roof of rental property under section 25-10 of the ITAA 1997.

Capital works deduction

The resealing work carried out on your rental property is considered to be capital works for which a deduction is available under section 43-10 of the ITAA 1997. The relevant rate allowed for your capital works deduction is 2.5% per annum.