Edited version of your written advice

Authorisation Number: 1012729468080

Ruling

Subject: Rental property repairs

Question 1

Are you entitled to an outright deduction for the body corporate levy incurred?

Answer

No.

Question 2

Are you entitled to a 2.5% capital works deduction for the body corporate levy?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You purchased a unit off the plan.

The building containing your unit suffered damage primarily related to waterproofing issues.

The problems primarily relate to faults in the construction of the property.

Work was previously undertaken to attempt to fix the problems.

Further repairs have become necessary and additional work is necessary to prevent future problems.

A consultant report has identified that the problems are consistent with a series of systematic failures due to defects in the building.

The report also identified that the issues to the inspected apartments were not a result of fair wear and tear and were assumed to be construction defects.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10.

Income Tax Assessment Act 1997 Section 43-10.

Reasons for decision

Summary

The work undertaken on the property was to rectify issues from the construction of the building. Therefore it is considered to be an initial repair and is consequently not deductible outright. However, as it is capital construction expenditure, it qualifies for the 2.5% capital works deduction.

Detailed reasoning

Section 25-10 of the Income Tax Assessment Act 1997 (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 Income tax: deductions for repairs 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:

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

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

3. the work is an initial repair.

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 1997.

In your case, you were required to pay a body corporate levy for work undertaken on the building in which your rental unit is located. The work undertaken was primarily required to fix faults in the construction of the building. While we acknowledge that a previous attempt was made to fix the issues, the additional work was required to remedy the issues that resulted from the construction of the building and not as a result of normal wear and tear. Therefore, the repair is considered an initial repair and is capital in nature. As a result, you are not entitled to a deduction for the expenses incurred for the body corporate levy under section 25-10 of the ITAA 1997.

Capital expenses

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.

A deduction is only available for the number of days that a property is rented, or available for rent, in any income year from the date that the works are completed.

A capital works deduction is generally claimed at a rate of 2.5% over 40 years.

In your case, the work undertaken on the building in which your rental unit is located is capital in nature and therefore you are entitled to a 2.5% capital works deduction for the body corporate levy paid for those works.