Edited version of private advice

Authorisation Number: 1051586988753

Date of advice: 14 October 2019

Ruling

Subject: Rental property deductions

Question

Are all the expenses incurred for the rental property an immediate deduction under 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 20XX

Relevant facts and circumstances

The property was tenanted for a long period of time by the same tenants. It was visible that the property had been neglected by the tenants and damaged by the tenant's pet. Out of a concern for the property, you engaged professional services to investigate the damage from the pets.

Damage report

A professional attended the property, to inspect the structural adequacy of footings that had been damaged by the pets. The professional estimated significant damage under the dwelling. There were two areas of most concern; in the dwelling.

The professional's opinion was that if the issues were left untreated the future structural integrity of the existing footings could not be guaranteed. The professional made recommendations for the dwelling.

During the work, the professionals were required to disconnect the plumbing for removal of the kitchen and in preparation for its later replacement. The plumbers inadvertently failed to crimp one of their connections leading to a major flood in the house which destroyed two areas of the dwelling. This resulted in more than six months of delay, due to subsequent drying and reinstatement works.

You have received compensation for the damage from the tenants and the bond was refunded to you. You have also received amounts from your insurance company for the damages.

You have provided receipts of some of the work done to the property.

While the property was being repaired you obtained a permit to extend the dwelling at a cost of $XXXX. The work was conducted over some months.

The property has now been tenanted recently.

Relevant legislative provisions

Income Tax Assessment Act 1997 section25-10

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 Division43

Detailed reasoning

Repairs

Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to the property 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. Paragraph 21 of 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.

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.

An improvement provides a greater efficiency of function and involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life. Where any of the repairs are improvements to how a thing was before, a deduction could not be claimed for it.

Repairs conducted on a property from damage from the tenants and their pets that brought existing parts to their original state would include: works to the footings under the property, the cost of the engineer's report, the payment to the professionals conducting these works, and cleaning. These repairs will be an allowable deduction under section 25-10 of the ITAA 1997.

Decline in value

Section 40-25 of the ITAA 1997 allows a deduction for the decline in value of a depreciating asset that you hold. A depreciating asset is an asset that can reasonably be expected to decline in value over the time it is used (section 40-30 of the ITAA 1997).

When a depreciating asset is destroyed, a balancing adjustment event occurs (section 40-295 of the ITAA 1997). You need to calculate a balancing adjustment amount to include in your assessable income if you receive insurance proceeds for a depreciating asset that has been fully depreciated. However, you may choose to offset the assessable balancing adjustment amount arising from the destruction of the asset against the cost of one or more replacement assets.

The cook tops, dishwasher, range hood, stove, swimming pool assets, floating timber and carpet floor coverings, window blinds and curtains are regarded as depreciating assets for Division 40 of the ITAA 1997 purposes.

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).

Section 43-40 of the ITAA 1997 allows a capital works deduction in given circumstances if the capital work that has been undertaken is destroyed. However, you are only allowed a deduction for un-recouped capital expenditure on a capital item included in a building that has been destroyed in an income year under section 43-40(1) provided that:

·         you have been allowed or are entitled to a deduction for capital works expenditure for your property;

·         there is an amount of undeducted construction expenditure for your property; and

·         you were using the property to produce assessable income immediately before the destruction or, if not neither you nor any other entity used your property for any other purpose since it was last used by you to produce assessable income.

Expenditure on demolishing existing structures is not an amount that can contribute to a deduction for capital works under section 43-10 of the ITAA 1997. This is because it is not construction expenditure (paragraph 43-70(2)(b)). However, such expenditure is taken into account in calculating a deduction under section 43-40.

The amount deductible under section 43-40 of the ITAA 1997 is calculated using the method statement set out in section 43-250. Step 1 in section 43-250 provides that the balancing deduction amount is the undeducted construction expenditure for the destroyed capital works that exceeds the amounts you have received, or have a right to receive, for the destruction of the capital works. Demolition expenditure acts to offset the lessening of deduction that occurs because of the fact that an amount has been received for disposing of the destroyed capital works.

Section 43-255 of the ITAA 1997 provides that the amounts you have received or have a right to receive for the destruction of the capital works include:

a)    an amount received under an insurance policy or otherwise for the destruction of the capital works, and

b)    an amount received for disposing of any property salvaged from the demolition, less any demolition expenditure incurred on the property.

The effect of this provision is to allow you to deduct an amount in the income year in which the capital works are destroyed for all of your construction expenditure that has not yet been deducted. However, you must reduce the deduction by any insurance and salvage receipts.

An entirety is defined as 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). Extensions, the replacement of an entire structure or unit or property such as a building, kitchen cupboards, are expenses that are capital or of a capital nature.

The kitchen benchtops, cupboards, sink, bathroom vanity, bathroom fixtures, fixed floor tiles, wardrobe fixtures and fittings and wiring. These items are permanently fixed in place and are considered to become part of the building and therefore capital works for Division 43 of the ITAA 1997 purposes.

Cost base

Landscaping and adding an extension to the house are improvements for which you cannot claim deductions. They would be included in the cost base on disposal of a property.

Apportionment

Where you have receipts that are for both repairs and capital expenses you need to apportion how much is for each and claim it under the respective label in the tax return.

Note that if you receive an insurance payment for lost rent for your rental property, you must include this as income in your tax return.