Edited version of your written advice

Authorisation Number: 1012921391042

Date of advice: 11 December 2015

Ruling

Subject: Rental property expenses

Question 1

Are you entitled to a repairs deduction under section 25-10 of the ITAA 1997 for the cost of your share of a special levy imposed on unit owners of a property owned under strata title for expenses incurred for repair work in the relevant financial year?

Answer

No.

Question 2

Are you entitled to claim a capital works deduction for the cost of your share of a special levy imposed on unit owners of a property owned under strata title for expenses incurred for repair work?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own a rental property.

You acquired this property in 20XX.

An initial quote for repairs to the unit block was in early 20XX.

You paid a special strata levy in 20XX to cover costs of remedial work to the building.

The contractor was paid for the work in the 20XX financial year.

The following work was undertaken:

• Repairs to concrete

• Replacement of dilapidated window sills

• Replacement of damaged glass

• Replacing 50% of roof guttering

• Patch and repair damaged render and paint

• Repairs to timber deck

• General painting and patch work

You advised that the repairs relate to damage sustained through wear and tear.

The repair work has restored the affected items to their previous state, and like for like materials have been used.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

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 rental property in 20XX. The initial quote for the repairs was made in 20XX.

You incurred expenses in relation to repairs to concrete, replacement of dilapidated window sills, replacement of damaged glass, replacing 50% of roof guttering, patch and repair damaged render and paint, repairs to timber deck, and general painting and patch work.

In consideration of the age of the building and the relatively short period you were in possession of this property, it follows that these items were in a 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.

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.