Edited version of private advice

Authorisation Number: 1051603770273

Date of advice: 7 November 2019

Ruling

Subject: Rental properties - repairs

Question 1

Are we entitled to an immediate deduction for the cost of replacing kitchen cupboards?

Answer

No

Question 2

Are we entitled to capital works deduction in relation to the kitchen works?

Answer

Yes

Question 3

Are we entitled to an immediate deduction for the cost of repairing the roof?

Answer

Yes

This ruling applies for the following period:

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

The scheme commences on:

1 July 2017

Relevant facts and circumstances

You purchased a duplex (the property) as joint tenants. You obtained a report from a qualified professional which detailed the roof was in good condition.

The property is rented out and producing rental income.

A number of years later, you were informed that property had leaking roof problems. A roofer inspected the property and advised that particular panels were leaking and the entire roof was now rusty and would continue to leak in other areas. The roofer recommended removing and replacing all the roof panels.

The kitchen was in its original state: the benchtop was tiled and the cupboards and drawers were chipboard. Wear and tear resulted in damaged shelves, cupboard doors and a missing front panel from a drawer.

The cabinets, shelves, benchtop, sink and taps were replaced. New LED lighting replaced the fluorescent light. Some painting also occurred.

You did not receive insurance payouts or any other payment in relation to the expenses.

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.

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, expenses which are capital, or of a capital nature are not deductible as repairs or maintenance. The following are examples of expenses which are capital or of a capital nature:

·         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.

The meaning of repairs

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.

If work done to property goes beyond what is a 'repair' in terms of section 25-10 of the ITAA 1997, any expenditure for the work is not deductible. The work may go beyond 'repairs' in terms of the section if it:

(a) changes the character of the property; or

(b) does more than restore its efficiency of function.

Repair is distinct from renewal or replacement

Renewal, replacement, or reconstruction of, the whole or substantially the whole of a thing or structure (entirety) is likely to be considered a capital improvement rather than a deductible repair.

What is an entirety?

Determining what is an entirety is a question of fact in each case. Taxation Ruling TR 97/23 Income tax: deductions for repairs states that a property is more likely to be an entirety if:

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

(b) 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

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

(d) the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law (paragraph 38 of TR 97/23).

Improvement or repair

When work is done to restore or fix a damaged item, we need to determine if the work undertaken is a repair or an improvement. Repairs generally restore the item to its former function and efficiency whereas improvements increase an items functionality and/or efficiency.

A repair may increase the items efficiency slightly and still be classed as a repair. However, where the item's function or efficiency is improved substantially or the work changes the function of the item, the work is considered to be an improvement and capital in nature.

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.

The rate of deduction for capital works for a residential rental property is 2.5% of construction expenditure over 40 years.

Application to your situation

Kitchen

In Case W77 89 ATC 698; (1989) 20 ATR 3888 the owner of a rental property was denied a deduction for a remodelling of a bathroom, amongst other expenditure, where repair was needed because of age, deterioration and general wear and tear. It was held that the work done in remodelling the bathroom was extensive and could be described as a complete renovation designed to improve the unit rather than simply to restore it.

In your case, you replaced all kitchen cabinets, cupboard doors, shelves, benchtop, sink and taps, LED lighting replaced an overhead fluorescent tube light, which indicates an improvement, a renovation of the kitchen rather than a repair. Remedying defects would be limited to repairing or replacing individual damaged items, such as replacing only the damaged shelves or kitchen doors. Although your intention may have been to restore the efficiency of function of the items replaced, you have gone beyond repairing worn items to a complete renewal of the kitchen as a whole.

Additionally, the cupboards are a separately identifiable thing representing an entirety in themselves and the expenditure on replacing the kitchen cupboards results in an improvement or a renewal or reconstruction of an entirety, the expenditure is not a repair but is capital in nature.

Therefore, when you are replacing the kitchen cabinets, shelves, benchtop, sink and taps, the work is considered to be a capital improvement and is not deductible as a repair under section 25-10 of the ITAA 1997. An annual capital works deduction of 2.5% of the cost of this item is allowable under Division 43 of the ITAA 1997.

Roof

In your case, the roof was leaking and in need of repair. The roof was merely repaired by its modern equivalent and to restore the original function.

Paragraph 40 of TR 97/23 specifically states that a roof is only part of a building and does not constitute an 'entirety'. The building itself is the 'entirety'.

It is considered that the work to rectify the problem is not an initial repair, is not the replacement of an entirety, and is not an improvement. As the work is considered a repair you are allowed an immediate deduction under section 25-10 of the ITAA 1997.