Edited version of your written advice

Authorisation Number: 1012882947879

Date of advice: 24 September 2015

Ruling

Subject: Work done to a rental property

Question 1

Are you entitled to a repairs deduction for the work undertaken on your rental property?

Answer

No.

Question 2

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

Answer

No.

Question 3

Are you entitled to a decline in value deduction for the new depreciating assets installed as part of the work undertaken on your rental property?

Answer

No.

Question 4

Are you entitled to a deduction for the replacement of the asbestos ceiling and walls as an environmental protection activity?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2015

The scheme commences on:

1 July 2014

Relevant facts and circumstances

You owned a rental property.

After the tenants vacated the property you undertook substantial work restoring the property.

Once the work was completed you moved into the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Section 40-25

Income Tax Assessment Act 1997 Section 40-755

Income Tax Assessment Act 1997 Division 43

Reasons for decision

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.

The cost of repairs to a property after cessation of income producing use is covered in Taxation Ruling IT 180. Paragraph 4 of IT 180 states that a deduction may be allowed for the cost of repairs to property providing:-

• the necessity for the repairs can be related to a period of time during which the premises have been used to produce assessable income of the taxpayer, and

• the premises have been used in the production of such assessable income of the year of income in which the expenditure is incurred.

It does not matter what use the property is put to after the repairs are carried out so long as the costs associated with the repairs are incurred in the same year as assessable income has been earned from the property.

Taxation Ruling TR 97/23 explains the circumstances in which deductions for repairs are allowable, and states that in section 25-10, the word 'repairs' has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

Distinction between a repair and an improvement

TR 97/23 states that with a repair, the work restores the efficiency of function of the property without changing its character. An improvement, on the other hand, provides a greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do.

It is acknowledged in TR 97/23 that to repair property improves to some extent the condition it was in immediately before repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10.

TR 97/23 states that what is a repair for the purposes of section 25-10 is a question of fact and degree in each case having regard to the appearance, form, state and condition of the particular property at the time the expenditure is incurred and to the nature and extent of the work done to the property.

If work done to property goes beyond what is a repair, any expenditure for the work is not deductible under section 25-10 (TR 97/23). The work may go beyond repairs if it:

• changes the character of the property; or

• does more than restore its efficiency of function.

(However, the cost of this work may be deductible under other provisions of the income tax law, for example as a capital works deduction or as a decline in value).

TR 97/23 states that if work done goes beyond repair and the whole cost is capital expenditure, no amount is allowable as a deduction for 'notional' repairs, that is, an estimate of what it would have cost if the property had in fact merely been repaired.

The issue of distinction between a repair and an improvement has been considered in many judicial and tribunal decisions.

In Case V167 88 ATC 1107; Case 12 (1986) 18 ATR 3056 (Case V167), work carried out to the rental property included the replacement of some of the original kitchen cupboards and fittings, which were slightly water damaged, by more modern units. The layout of the kitchen was reorganised, and an island bench with cupboards underneath was provided which was in keeping with modern concepts of design. Overall no additional storage facilities were provided. In addition, a timber framed window in the kitchen was replaced by an aluminium framed window (set in the same opening). The window was said to have deteriorated due to weathering and water damage.

It was held that the kitchen was restructured according to modern standards, while the deterioration of the window frame was not such as to make replacement the most appropriate means for effecting any necessary repairs. Accordingly, the works carried out on the kitchen and the window frame could not be classified as repairs and the expenses were not deductible. P.M. Roach (Senior Member) stated:

The kitchen was part of the lettable structural entity, but I am satisfied upon the evidence that the kitchen was "renovated" not so as to only make good deficiencies which had developed over a period of time and to only restore the kitchen to its original condition so far as that was possible. Instead, the work undertaken was to restructure the kitchen according to a new standard perceived, according to the fashion of the time, as being a better standard. Even though cupboard space was not increased the layout and arrangement; the method of construction; and the appearance of the kitchen were all changed substantially. I am not persuaded that any portion of those works should be characterised as "repairs". Nor did the window replacement constitute repair. It too contributed to the image of the new kitchen.

As discussed above, repair involves a restoration of property to a condition it formerly had without changing its character.

In your case the work performed at your rental property was enlarged into a substantial alteration or refurbishment of the property. It did more than meet the need for restoration of efficiency of function. The work goes beyond a repair, and is an improvement due to the nature and extent of the work done (as in Case V167). The cost of the work undertaken is capital expenditure, and a deduction is not allowable for the expenditure 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, you carried out capital works on your rental property after the income producing function of the property had ceased. You are therefore not entitled to a deduction for the capital works as the property is no longer available for rent.

Decline in value (depreciation)

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value of a depreciating asset to the extent that it is used for a taxable purpose.

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

However, as the new depreciable items were installed after the income producing function of the property had ceased, you are not entitled to a deduction for the decline in value under section 40-25 of the ITAA 1997.

A deduction may be allowed for the balancing adjustment events occurring in relation to the old depreciating assets that were replaced if amounts remain unclaimed in relation to the decline in value of those replaced assets.

Environmental protection activities

Section 40-755 of the Income Tax Assessment Act 1997 (ITAA 1997) allows you to claim deductions for expenses that were incurred for the sole or dominant purpose of environmental protection activities.

The Explanatory Memorandum to the Taxation Laws Amendment Act (No. 5)1992 (the EM), which introduced former subsection 82BM(2) of the Income Tax Assessment Act 1936 (ITAA 1936), provides guidance in the interpretation of section 40-755 of the ITAA 1997. The EM states:

Expenditure will only be for the sole or dominant purpose of carrying on an eligible environment activity if it is primarily directed to that environment protection activity. A deduction will not be available if the protection of the environment is only a residual or subsidiary purpose of the taxpayer.

In your case, it is considered that the asbestos ceiling and walls were removed as part of renovating the property and the dominant purpose of the expenditure was not for environmental protection purposes. Therefore, you are not entitled to a deduction for the removal of the asbestos ceiling and walls as an environmental protection activity.