Edited version of your written advice

Authorisation Number: 1051329372768

Date of advice: 19 January 2018

Ruling

Subject: Rental property work

Question 1

Is the work completed on your investment property before your tenant moved in a deductible repair?

Answer

No.

Question 2

Are you entitled to claim a deduction for the decline in value for the carpet put in your investment property?

Answer

Yes.

Question 3

Are you entitled to claim a capital works deduction of 2.5% of the remainder of the work on your investment property?

Answer

Yes.

This ruling applies for the following period:

Year ending 30 June 2017

The scheme commenced on

1 July 2016

Relevant facts

You purchased an investment property recently as a sole owner. The property was purchased with the intention of it being a rental investment property.

The loan is used solely for your property.

Prior to settlement, the previous tenant was terminated from the lease. The previous tenant left the property in major disrepair. You took over on settlement and the tenant had still not vacated the property completely. Major work had to be conducted to the property.

A tenant approached you and you entered into an agreement where if you conducted the necessary work, the tenant would sign a lease.

You did the work as soon as you could and the work was completed within a few months.

The work done was a complete house renovation and included:

● total kitchen replacement as previous kitchen was unusable and had dangerous electrical fixtures,

● total bathroom replacement as previous bathroom and septic disposal units were unusable,

● painting throughout the property as walls were badly damaged and smoke damaged,

● recarpet and tile throughout the house as unrepairable floor fixtures were present.

The tenant moved in a week after the work was completed.

The tenant pays market rent as recommended by the real estate.

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

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 Income tax: deductions for repairs 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 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.

As highlighted in paragraph 59 of TR 97/23, if expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, such expenditure incurred on an initial repair after property is acquired is capital expenditure and is not, therefore, deductible under section 25-10 of the ITAA 1997. 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.

Paragraph 61 of TR 97/23 states:

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… 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.

In your case, the property needed extensive work done before the tenant could move in. The property was in disrepair at the time of acquisition. The poor condition of the property is not attributable to damage that occurred during the time you rented the property. As per TR 97/23, the renovation work is regarded as initial repairs and capital in nature.

Furthermore, the kitchen and bathroom are separately identifiable items with their own function. As a consequence, they are an entirety in themselves and their replacement is a renewal of the entirety. The expenditure is capital in nature and not a deductible repair (Lindsay v Federal Commissioner of Taxation (1960) 106 CLR 377; 12 ATD 197; (1960) 8 AITR 99).

As the work carried out to your property is capital in nature, no deduction is allowable under section 25-10 of the ITAA 1997.

However, as outlined below you can claim an amount over a number of years for your carpet depreciation and capital works for your rental property.

Depreciating assets

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value (depreciation) of a depreciating asset you hold, to the extent the asset is used for a taxable purpose.

Carpet is regarded as a depreciating asset for Division 40 of the ITAA 1997 purposes. A deduction for its decline in value is an allowable deduction where it is used for income producing purposes. As your property is rented, a deduction for the relevant depreciation amount of the carpet is an allowable deduction. For details on how to calculate the allowable depreciation deduction, please refer to the Australian Tax Office’s Guide to depreciating assets which is available on the website ato.gov.au.

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).

In your case your expenditure is regarded as improvements and construction expenditure for which a deduction is available under section 43-10 of the ITAA 1997. That is, a 2.5% deduction is allowed under Division 43 of the ITAA 1997 for the work carried out to your property after XX March 20XX.