Edited version of your written advice

Authorisation Number: 1013045839864

Date of advice: 4 July 2016

Ruling

Subject: Rental property expenses - repair or improvement

Question and Answer

Is the cost of replacing a retaining wall located on your rental property an allowable deduction as a repair?

No.

Is the cost of replacing the retaining wall capital expenditure, which is eligible for an annual write-off deduction under the capital works provisions?

Yes.

This ruling applies for the following period

Year ended 30 June 20zz

The scheme commences on

1 July 20yy

Relevant facts and circumstances

Your property is rented for income producing purposes.

Your property was built in 20xx.

You hold the property as a joint tenant with your spouse.

Your property is cut into a slope and required a retaining wall which was built at the time of construction in 20xx.

Your property was certified to be in good condition at the time it was built.

During the course of ownership you have had routine property manager inspections completed which was done; both of which noted no drainage/earthwork cut movement/retaining wall issues.

Upon completion of a property manager's inspection in January 20zz, it was reported that there was crumbling earthwork cut/wall movement with drainage issues.

A Building Inspection Report was completed for the whole building including the drainage, crumbling earth works underneath the house, timber retaining wall underneath the house, wet footing and house foundation on a cut & fill slope and structure under the house recommended remedial repair works.

The Building Inspection Report noted:

• That the soil in the subfloor space was seen to be affected by widespread dampness in the form of standing and running water. The pattern of dampness seen was commonly associated with defective plumbing and lack of subsoil drainage. An investigation by competent person was recommended to determine the extent of remedial work that is required and this recommendation should be implemented as a matter of urgency.

• Erosion was found to be the subfloor soil possibly due to inadequate ground drainage; with some of the pier foundations which are located near the soil erosion. It recommended stability Inspection & Report is carried out by Registered Engineer appropriately experience in slope stability matters. This recommendation should be implemented as soon as possible.

• Additional drainage is required along the base of the subfloor area to divert water flow away from the house foundations built on a steep cut and fill slope. Excessive moisture retention around the house could potentially contribute to foundation movement and termite attraction. This recommendation should be implemented as soon as possible.

• The timber sleeper retaining wall located in the subfloor appears to be built sub-standard. Inspection by competent person and remedial work is required. This recommendation should be implemented as soon as possible.

In March 20zz you obtained a quote from a Concreter for the work required to improve the drainage, contain the crumbling earth works cut/wall, stabilising supporting pillars and redirect the surface run-off water away from retaining wall footings and house foundation built on a slope.

You carried out the required repair work as outlined in the Building Inspection Report.

You incurred the costs and have provided the evidence of the expenditure.

No insurance or other monetary recovery was available

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Section 43-15

Income Tax Assessment Act 1997 Section 43-20

Income Tax Assessment Act 1997 Section 43-25

Income Tax Assessment Act 1997 Section 43-140

Income Tax Assessment Act 1997 Section 43-30

Income Tax Assessment Act 1997 Section 43-70

Reasons for decision

Section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) generally allows a deduction for expenditure incurred on repairs to premises or plant held or used by a taxpayer for the purpose of producing assessable income. However, capital expenditure is not deductible under section 25-10. 

Taxation Ruling TR 97/23 explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10. 

TR 97/23 states that in its context 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 to be repaired and contemplates the continued existence of the property. Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.  

Expenditure incurred for repairs is not deductible under section 25-10 if the expenditure is of a capital nature. TR 97/23 states that expenditure for repairs to property is capital expenditure if the expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety. 

The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment' (Lindsay v FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201). In Lindsay's case, the taxpayer company was a slip proprietor and ship repairer. It claimed a deduction for the cost of reconstructing one of two slipways. In finding that the work was not repairs, Kitto J rejected the taxpayer's submission that either the whole slip (comprising the slipway, hauling machines, cradles and winches by which vessels were manoeuvred on to it) or the whole of the business premises containing the slipway should be regarded as the relevant entirety. His Honour decided that the slipway was an entirety by itself and not a subsidiary part of a larger whole. 

Property is more likely to be an entirety, as distinct from a subsidiary part, if (TR 97/23):

• the property is separately identifiable as a principal item of capital equipment; or 

• the thing or structure 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; or 

• the thing or structure is a separate and distinct item of plant in itself from the thing or structure which it serves; or 

• the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law.

It will be taken from this that the retaining wall was a reconstruction of the entirety.

The issue of repairs to retaining walls has been considered in a number of cases, including Case S13, 85 ATC 171 and Mt Isa Mines Ltd v FC of T 90 ATC 4267. 

In Case S13, two retaining walls built on a rental property to prevent soil erosion were each held to be an 'entirety'. The replacement following storm damage, with two new retaining walls which were higher, stronger and of different material, was held to be an improvement to a fixed capital asset and not repairs. 

In Mt Isa Mines Ltd v Federal Commissioner of Taxation, a mining company constructed a retaining wall to create a tailings dam on a mine site. The retaining wall was intended to be the first stage of a much larger development. Following seepage through the retaining wall a new retaining wall, or embankment, was constructed with the result that the old retaining wall was submerged. The Federal Court held that the expenditure incurred in building the new retaining wall was not deductible because it was an outgoing of capital or of a capital nature and did not constitute repairs to the old retaining wall or to the dam. 

In your case, your expenditure on replacing the retaining wall is not a deductible repair under section 25-10 ITAA 1997 because the whole retaining wall was replaced, making it a reconstruction of the entirety. The cost of replacing an entire retaining wall with a new retaining wall is of a capital nature.

Deduction for Capital Works 

Your expenditure on replacement of the retaining wall is not deductible outright (under section 25-10) in the income year in which it is incurred, because it is capital expenditure. However, a deduction may be available under the capital works provisions.

The capital works provisions allow a deduction for certain capital expenditure on the construction of buildings and other capital works which are used for the purpose of producing assessable income. Eligible construction expenditure is written off over a number of years. 

Division 43 applies to capital works being certain buildings, and also capital works that are structural improvements begun after 26 February 1992. Examples of structural improvements include fences and retaining walls. Your expenditure on the new retaining wall is therefore subject to the capital works provisions. 

The amount you can deduct is a portion of your construction expenditure. In the case of structural improvements begun after 26 February 1992 the rate of deduction is 2.5%. However, not more than 100% of your construction expenditure can be deducted. This imposes a time limit on the period over which your construction expenditure can be deducted. In your case, the construction expenditure in relation to the new retaining wall may be written off over a 40 year period, at a rate of 2.5% per year.

However, it should be noted that the write-off deduction is allowable only for the period your property is rented or is available for rent. It should also be noted that you cannot deduct an amount for any period before the completion of construction of the capital works (the retaining wall).  

Section 43-70 ITAA 1997 defines construction expenditure as capital expenditure incurred in respect of the construction of capital works. Taxation Ruling TR 97/25 states that construction expenditure includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits. 

However, section 43-70 ITAA 1997 states that construction expenditure does not include:

• expenditure on acquiring land; or

• expenditure on demolishing existing structures; or

• expenditure on clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation works; or

• expenditure on landscaping.