Edited version of your written advice

Authorisation Number: 1012785506003

Ruling

Subject: Deductions for repairs

Question 1

Is the 'maintenance and repairs' expenditure incurred deductible in full in the year it was incurred?

Answer

No.

Question 2

Is the 'maintenance and repairs' expenditure incurred capital in nature and eligible for a capital works deduction?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2014

Year ended 30 June 2015

Year ended 30 June 2016

The scheme commenced on:

1 July 2013

Relevant facts and circumstances

You own an historic heritage listed commercial and retail building.

The building has been held by family members for a considerable time and is currently tenanted by retail businesses.

The Certificate of Title of this building was transferred to the current legal owners in 20XX.

The first floor has not been utilised for either income producing or personal use since it came into the family possession.

This has also been the case since ownership of the building was transferred to the current legal owners in 20XX.

You received notice from your local council by way of an order to secure the building, detailing works required to be completed in order to make the building safe.

As per the council order, you engaged a qualified structural engineer to conduct a full survey of the buildings current state and prepare a report identifying all remedial works required to make the building structurally sound and fit for human occupation.

As the building is heritage listed, any works to be conducted were required to be undertaken with the guidance and consideration to the relevant State heritage Acts.

You have provided a report from structural engineers detailing works to be carried out on the building necessary to comply with the council order.

You have provided a copy of the development application (DA) submitted to council as well as the approval for these necessary works to be completed.

Documentation provided by you states that "The completion of the stabilisation work will allow internal refurbishment to commence and this in turn will make the first floor useable. Use of the first floor will assist in sustaining the long term conservation of the place and return some fine spaces to a state where they can be enjoyed."

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Section 25-10 of the Income Tax Assessment Act (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 tax legislation. Accordingly, it takes its ordinary meaning. 'Repair' involves a restoration of a thing to a condition it formerly had without changing its character (W Thomas & Co v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; 9 AITR 710) (the Thomas Case).

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

The expenditure is an initial repair if the defect, damage or deterioration existed at the time of acquisition of the property and did not arise from the operations of the person who incurs the expenditure.

The leading Australian case in this area is the High Court decision in the Thomas Case. There, Windeyer J held that roof, guttering, wall, basement floor and wooden floor repairs and painting of a building in the year of income it was acquired was expenditure of a capital nature. An initial repair lacks a connection with the conduct or operations of the taxpayer required to 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 and therefore relates to the establishment of the profit-yielding structure. As it is capital expenditure, it is not deductible under section 25-10 of the ITAA 1997.

Taxation Ruling TR 97/23 provides guidelines on the deductibility of repair expenses for rental properties and explains the different types of repairs, one of which is described as initial repairs.

Paragraph 59 of TR 97/23 confirms that expenditure incurred on initial repairs is capital expenditure and is therefore not deductible under section 25-10 of the ITAA 1997. This paragraph also states that the cost of effecting initial repairs is still not allowable even if some income has been earned before the repair expenditure is incurred. In other words, the character of initial repairs is not altered because income is derived from the property before the expenses are incurred on the initial repairs.

Furthermore, it is immaterial whether or not the taxpayer was aware of the need for the repairs at the time of acquisition or if the purchase price reflected the need for repairs (paragraphs 5 and 59-61 of TR 97/23; Law Shipping Co Ltd v. Commissioners of Inland Revenue (1923) 12 TC 621 and the Thomas Case.

Application to your situation

In your case, you acquired the building in 20XX. The building was constructed in the 1930's and has suffered substantial deterioration over the years due to poor reinforcement cover in the concrete, under designed cantilevering and initial design and construction deficiencies.

You are incurring expenses in relation to replacing balustrades, balconies, turrets, balcony and window awnings, partition walls and render to return the building to a safe and useable standard as ordered by the local council.

Completion of the listed works will also facilitate future use of the first floor offices which have not been in a useable state for a considerable time. This has the potential of opening up a new income earning capacity for you that was not available at the time of your acquisition of the building and would not become available without this current work.

In consideration of the age of the building and the relatively short period you have been in possession of this property, it follows that these items were in a considerable state of disrepair at the time of your acquisition of the property and the repair work did not arise as a result of your renting out of the property.

The repairs are addressing a condition that existed at the time of acquisition and is therefore to be treated as initial repairs and capital in nature. The works will result in the building achieving a much better state of repair than it had when you first acquired it in 20XX.

Accordingly, you are not entitled to a deduction under section 25-10 of the ITAA 1997 for expenses incurred in restoring the building.

Capital works deduction

Although you are not entitled to a deduction for initial repairs, expenditure may be deducted under Division 43 of the ITAA 1997. Broadly speaking, Division 43 of the ITAA 1997 provides a deduction for construction expenditure on capital works.

Capital works generally include improvements to buildings (subsection 43-20(1) of the ITAA 1997). This property is a building to which Division 43 of the ITAA 1997 applies and the initial repairs you have undertaken are an improvement to that building.

The expenses you have incurred for initial repairs qualify as construction expenditure for the purposes of Division 43 of the ITAA 1997.

A deduction of 2.5% of the initial repair expenses can be claimed for 40 years from the date construction was completed. If construction was completed part of the way through the income year, you can claim a pro-rata deduction for that part.