Edited version of your written advice

Authorisation Number: 1013074541602

Date of advice: 22 August 2016

Ruling

Subject: Rental property maintenance

Question 1

Is the work carried out to your rental property a deductible repair?

Answer

No.

Question 2

Are you entitled to a capital works deduction for the work carried out to your rental property?

Answer

Yes.

This ruling applies for the following periods:

Year ended 30 June 2017

Year ended 30 June 2018

The scheme commenced on:

1 July 2016

Relevant facts:

Your property has been used as a residential rental property since you purchased it more than 30 years ago.

You manage the property yourself, and it is leased at the current market rate.

Parts of the building will have to be removed and replaced due to damage. Affected parts of the building include the floor bearers, floor joists and floorboards, roof trusses, window frames, door frame and door architraves.

The damaged materials will be removed and replaced with the same or similar materials to bring the building back to its original condition. The kitchen and bathroom will have to be removed to assess the damage, although the concrete slab on which the laundry and bathroom sit may be able to stay.

You will not be claiming for any additions, alterations or modifications to the building.

The expenditure incurred for the work to the property will be met by you.

The house had suffered from extreme infestation.

The structural integrity of the building has been affected, and major structural materials need replacing.

There is approximately a 40mm floor drop in level on some parts of the house. Structural beams and rafters have been affected, and the tiles on the roof will have to be removed.

You intend to use existing brickwork, most of the windows and building footprint, replacing roof trusses, beams, most of the walls, to bring it up to a standard where it may be rented again.

You will endeavour to recycle or reuse existing items such as kitchen plumbing and wiring. Taps need to be replaced as they have been re seated many times. Tiles will have to be replaced. The existing stainless steel sink may be reused. Some of the floor mounted kitchen cabinets will need to be replaced; the kitchen layout will not change.

Bathroom layout will remain the same. The concrete slab will stay, the bath will need to be recoated or replaced. The bathroom cabinet has been removed due to extensive damage. Toilet pedestal may be able to be reused.

All existing brick walls, windows, concrete slab to laundry, bathroom and concrete patio will remain.

Existing brick and piers, brick carport remains. Electrical board, water supply, water meter, fencing, and electrical cable will be reused where possible.

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 1997 (ITAA 1997) allows a deduction for the cost of repairs to premises used for income producing purposes, to the extent that the expenditure is not capital in nature.

Taxation Ruling TR 97/23 explains the circumstances in which deductions for repairs are allowable. TR 97/23 states that what is a repair for the purposes of section 25-10 of the ITAA 1997 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.

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. 

Repair is distinct from renewal or reconstruction.

Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety.

What is an '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), 'a physical thing which satisfies a particular notion' (the Lindsay case at 106 CLR 384; 12 ATD 201) and 'not necessarily the whole but substantially the whole of the [property] under discussion' (the Lindsay case at 106 CLR 383-4; 12 ATD 200). There is no one correct test for what is a subsidiary part and what is an entirety. Which approach to adopt depends on the facts in each particular case and, even then, the question is one to be answered in the light of all the circumstances it is reasonable to take into account (see Regent Oil Co Ltd v. Strick Inspector of Taxes [1965] 3 All ER 174 at 179; Brown (Inspector of Taxes) v. Burnley Football and Athletic Co Ltd [1980] 3 All ER 244 at 255).

Property is more likely to be an entirety if:

• 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.

Although a reconstruction of the whole of property (for example, fencing or a railway) is not a deductible repair, a series of restorations of the property could be undertaken over a period of time that progressively restores subsidiary parts of the whole. The progressive restoration would involve a series of deductible repair expenses. It is a question of fact and degree whether the work is the reconstruction of an entirety or a progressive restoration of subsidiary parts of the entirety over a period of time. Relevant considerations in drawing the line of demarcation here include:

• the nature, scale and dimensions of the work in proportion to the nature, scale and dimensions of the property involved (the larger the work in comparison with the scale and dimensions of the property, the more likely a reconstruction of the entirety is involved);

• the period of time over which the work is done (the shorter the period, the more likely a reconstruction of the entirety is involved); and

• whether the work is done in accordance with an on-going program of restoration (more likely to constitute deductible repairs) or done in one operation (more likely to constitute a non-deductible reconstruction of the whole property).

In your case, the first two points above are the most relevant:

The scale of work proposed in comparison to the whole of the property indicates effective replacement of the whole. The lack of a proposed on-going program of restoration and the nature of the asset would indicate that work will be carried out as expediently as possible.

These points, and the close comparison of cost between demolition and total rebuilding and the work you intend to carry out, coupled with the replacement of major elements such as:

• Timber floor components entirely

• Roof entirety

• Interior walls

• Kitchen and bathroom furniture

• Door frames and architraves, window frames

• Structural beams and rafters,

indicate that you are incurring a cost congruent with replacing the entirety of the house rather than repairing it.

The work done to your rental property is considered capital in nature and not deductible as a repair. Therefore, you are not entitled to a deduction for repairs for the work done to the property under section 25-10 of the ITAA 1997.

Capital works deduction

Division 43 of the ITAA 1997 allows a deduction for capital expenditure incurred in constructing capital works including building and structural improvements where a residential property is used for income producing purposes. This deduction is referred to as a capital works deduction.

The deduction is available on the cost of construction and would include work done to the property.

In your case you will incur construction expenditure on the work done to the property which occurred after 15 September 1987 and accordingly you would be able to claim a capital works deduction of 2.5% per year. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997).

It should also be noted that expenses of a capital nature may form part of the cost base of the property for capital gains tax purposes, but not generally to the extent that capital works deductions have been or can be claimed for them.