Edited version of your written advice

Authorisation Number: 1051299262655

Date of advice: 2 November 2017

Ruling

Subject: Rental property works

Issue 1 Question 1

Are you entitled to an immediate deduction for the replacement of a damaged blind and building consultant fees against your rental property?

Answer

Yes

Issue 2 Question 1

Are you entitled to a deduction for repair works in relation to failure of waterproofing due to a poorly designed grated drain?

Answer

No

Issue 3 Question 1

Are you entitled to a deduction for travel expenses to meet with the builder about repair works on your rental property?

Answer

No

This ruling applies for the following period

Year ending 30 June 2017

The scheme commenced on

1 July 2016

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Relevant facts

Mould and water damage was discovered in a room of the rental property.

The driveway overflowed with rainwater during a storm event due to drainage issues.

An insurance claim was made and declined advising the damage is not the result of an insured event but from maintenance issues and structural building defects.

A building inspector concluded that the initial construction was sub-standard and this was the main reason for the ingress of water along with faulty modifications.

Works were carried out to parts of the affected room and the driveway.

The driveway was ripped up and re-laid as well as excavation work and backfilling the affected area in order to repair the poorly designed grated drain at the end of the driveway.

Reasons for decision

Repairs

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. The ruling further states that repairs mean 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.

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 costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.

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 of the ITAA 1997.

Repairs and maintenance

Expenditure for repairs you make to the property may be deductible. However, generally the repairs must relate directly to wear and tear or other damage that occurred as a result of your renting out the property.

Repairs generally involve a replacement or renewal of a worn out or broken part, for example, replacing worn or damaged curtains, blinds or carpets between tenants. Maintenance generally involves keeping the property in a tenantable condition, for example repainting faded or damaged interior walls.

However, the following expenses are capital, or of a capital nature, and are not deductible:

● replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)

● improvements, renovations, extensions and alterations, and

● initial repairs, for example, in remedying defects, damage or deterioration that existed at the date you acquired the property.

You may be able to claim capital works deductions for these expenses; for more information, see capital works deductions on page 24 of the Rental Properties Guide 2017. 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). For more information, see the Guide to capital gains tax 2017. See also Cost base adjustments for capital works deductions on page 27 of the Rental Properties Guide 2017.

You cannot claim the total costs of repairs and maintenance in the year you paid them if they did not relate directly to wear and tear or other damage occurring due to renting out your property. These are capital expenses you may be able to claim over a number of years as capital works deductions or deductions for decline in value.

Initial repairs are of a capital nature and not deductible

Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so, whether the property is purchased or obtained under lease or licence by the taxpayer. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred: but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs.

The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs the expenditure.

It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price (or lease rentals) reflected the need for repairs. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view.

An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that 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. Initial repair expenditure relates to the establishment of the profit - yielding structure. It is capital expenditure and is not deductible under section 25-10.

Capital works

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.

Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997).

Capital works used to produce income, including buildings and structural improvements, are written off over a longer period than other depreciating assets.

The capital works deduction is available for:

● buildings or extensions, alterations or improvements to a building

● structural improvements such as sealed driveways, fences and retaining walls

● earthworks for environmental protection, such as embankments.

Conclusion

As the repair works were carried out in relation to sub-standard construction of the property, all work to remedy the damage is considered Capital works. The deduction for capital works for a residential property is 2.5% claimed over a period of 40 years from the date construction was completed. If the construction was completed part of the way through the income year, you can claim a pro-rata deduction for that part.

As your travel expenses are related to the capital works carried out these will form part of the capital works deductions.

The immediate deduction for the replacement of the damaged blind is allowable as repairs generally involve a replacement or renewal of damaged goods. The fees relating to the building consultant inspection is also allowable, as this was required to determine the reason for the damage.

ATO view documents

Taxation Ruling TR 97/23