Edited version of private advice

Authorisation Number: 1051613917304

Date of advice: 15 January 2020

Ruling

Subject: Rental property deductions

Question 1:

Are the following itemised expenses incurred to repair the residential rental property to render it safe for occupation deductible in full immediately against rental property income for the year ended 30 June 20XX?

·         Supplier - Replacing damaged security screens

·         Supplier - Repair crack in the window glass

·         Supplier - Servicing heater

·         Supplier - re-install air conditioner

·         Supplier - Supply and replace damaged weatherboards and fascia

·         Supplier - Reblocking of domestic building

·         Supplier - Waste disposal

·         Supplier - Roof tiling on rebed and point and safety rail

·         Supplier - External painting of whole house, decking and step oil

Answer

Yes

Question 2:

(i) Can the following expenses be claimed over several years?

·         Supplier - Gas cook top and oven pack, silver dishwasher, slide out rangehood

·         Supplier - Full house renovation and variations

·         Electrical:

o   Supplier - Electrical works re: installation of underground pit

o   Supplier - Electrical works re: installation of underground pit

(ii) If yes, how many years

Answer

(i)            Yes.

(ii)           For the gas cook top and oven pack, dishwasher and rangehood you can claim a deduction for the decline in value and choose to use either the effective life the Commissioner has determined for such assets or your own reasonable estimate of its effective life.

For the expenses relating to the full house renovation, variations and electrical, you can claim capital works deductions at 2.5% of the construction cost for 40 years from the date the construction was completed.

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You own a residential rental property located at Site 1 (the property)

You purchased the property on XX/XX/XXXX for $X

The property is held as joint tenants in the following interests:

·         Taxpayer 1

·         Taxpayer 2

The original construction date of the property was circa XXXX

The property was extended and renovated in XXXX

You advised:

·         The property has been tenanted since acquisition on XX/XX/XXXX to independent and non-related tenants. You or your family have never lived in the property

·         The property was subdivided into two separate lots on XX/XX/XXXX

·         A residential property was constructed on the new subdivided lot at the back of the original property. The new property is known as Site 2 and is your residence

·         Prior to renewal of the tenancy agreement, in view of the ongoing complaints from the tenants, you appointed Company A to inspect and assess the condition of the property.

You provided a copy of the Company A Property Assessment Report (Company A Report) dated XX/XX/XXXX

The Company A Report indicates:

·         The condition of the property with respect of its age is "reasonably maintained"

·         The property, albeit with later XXXX extension, appears to be in original condition

·         There are major and serious structural defects evident:

-        Damp - bathroom shower leaks (and likely rotten flooring)

-        Framing - roof rafter decayed (pest infestation)

-        Stumps/Piers - rotting

-        Timber Rot - rear deck floor

-        Roof - leaks, old broken tiles, defective flashings

·         Other minor defects being normal maintenance items were identified:

-        Site drainage

-        Fencing

-        Timber rot and paint finish

-        Cracking

-        Exhaust fan faulty/missing

-        Carport upgrade

You advised:

·         Notice to tenants to vacate was verbally advised on XX/XX/XXXX and written notice on XX/XX/XXXX

·         The tenant vacated at the end of XX/XX/XXXX and the works commenced soon thereafter

·         Repairs commenced:

-        Re-blocking/restumping - XX/XXXX

-        Roof repairs - XX/XXXX

-        Internal repairs - XX/XXXX

-        Electrical works completed - End XX/XXXX

·         Repairs were completed in XX/XXXX

·         Advertising for new tenants commenced on XX/XX/XXXX

·         On satisfactory completion of the repairs, the property was advertised as available for rent and was rented out to independent and non-related tenants.

·         The property was relet on XX/XX/XXXX

·         All expenses for the repairs have been paid by the owners

·         No modifications were made in the design of the building except those as required to meet the relevant Australian legislation and standards

·         All repairs were carried out by independent and appropriately qualified, licenced and registered trades

·         No capital works deductions (special building write offs) claimed.

·         You did not receive an insurance or other payment for repairing or replacing items

·         The rental of the property was privately managed until towards the end of XX/XXXX (prior to commencement of the building works) when the agent took charge of leasing the property.

·         The property was advertised for rent through the agent's website, Realestate.com website and a billboard on the property (following completion of the building works). The gross weekly rental amount received after completion of the building works was $X per week. The rental amount was assessed by the agent. The rent was in line with other similar rentals in the area.

You supplied invoices relating to the property totalling $X for the following expenses:

An unsigned and undated Home Improvement Contract was provided between Taxpayer 2 and builder, for major domestic building work consisting of a full house renovation of the property

The tax invoice from builder outlines building works totalling $X as follows:

Removing

Remove and dispose all rubbish including removing existing floor covering in the kitchen

Carpentry

Remove two walls in the kitchen to open up the meals room (install structural beams to support the roof - if needed)

Create second bathroom near toilet (relocate return air for ducted heating)

Construct new outside decking approx. 3600mm x 2600mm (treated pine deck with treated pine structure)

Plumbing - rough in and fit-off

Bathroom 1: single vanity, bathtub, shower, toilet

Bathroom 2: single vanity, shower, toilet

Kitchen: dual sink, dishwasher, gas cook top

Laundry: Sink, washing machine

Electrical - rough in and fit-off

30 x led down lights for all house

10 x double power points

2 x 2 heat tastic (fan/heat/light)

(if electrical switchboard is not up to date with A.S., extra cost may incur to comply with A.S.)

Plastering

Patch, re-plaster and prep for paint al necessary walls (removed or damaged by us)

Bathroom 1

Supply and install: 1 x 900 x 900mm acrylic shower base, 1 x wall mixer, 1 x shower head, 1 x 900 x 900mm semi frame-less shower screen

1 x wall mixer and spout, 1 x 900mm vanity, white 2pac with ceramic top, 1 x basin mixer, 1 x back to wall toilet

Tiles: floor - ceramic 600 x 300mm grey, walls - ceramic 600 x 300mm white (shower walls 2m high, bathtub front/top/above and vanity back splash), grouting and caulking

Use existing bathtub

Waterproofing (to A.S. standards)

Bathroom 2

Supply and install: 1 x 900 x 900mm acrylic shower base, 1 x wall mixer, 1 x shower head, 1 x 900 x 900mm semi frame-less shower screen, 1 x 900mm vanity, white 2pac with ceramic top, 1 x basin mixer, 1 x back to wall toilet

Tiles: floor - ceramic 600 x 300mm grey, walls - ceramic 600 x 300mm white (shower walls 2m high, bathtub front/top/above and vanity back splash), grouting and caulking

Waterproofing (to A.S. standards)

Laundry

Supply and install standard size cabinets - white 2pac panels and doors, handles (builders range), base cabinets approx. 2lm, linen closet new shelf's and door, splash back tiling - ceramic 600 x 300mm white gloss, grouting and caulking

1 x laundry sink

1 x laundry mixer

Kitchen

Supply and install standard size cabinets - White 2pac panels and doors, Handles (builders range), Base cabinets approx. 5lm, Over head cabinets approx. 2lm, 20mm man made stone benchtop (builders range) approx. 5lm

Splash back tiling - ceramic 600 x 300mm white gloss, grouting and caulking

1 x dual sink

1 x kitchen mixer

Appliances supplied by client: 1 x 600mm gas cook top, 1 x 600mm electric oven (plugin), 1 x 600mm slide out range hood (in cabinet), 1 x dishwasher

Painting

Internal

Repaint: walls (low sheen) colour white, Ceiling (flat) colour white, Architraves, skirting and doors (semi gloss) colour white

Carport

Construct new carport approx. 3 x 6m (permit may be required)

Treated pine structure

Colourbond roof sheeting and roof plumbing (use existing storm water)

The tax invoice from builder outlines variations totalling $X as follows:

Variation 1

Electrical Board upgrade: Single phase meter box, single phase meter box wiring, single phase switchboard with 2 safety switches, 16mm single phase consumer mains, main earthing system, disconnection fee, reconnection fee, electrical inspection, electrical certificate

Floor repair/replace to laundry and bathroom: Remove and dispose, yellow tounge, support timber

Floor repair in hall and bedroom: remove and dispose, pine flooring, support timber, seal to match

Laundry door and wall: 820mm door and door knob, carpentry, plastering, painting, electrical

Create ensuite: Rearrange bathroom to create ensuite, block old door way, remove and disposal, 820mm door and door knob, carpentry, plastering, painting

Toilet: Remove window, relocate plumbing, carpentry, plastering

Wall in living: Remove and disposal, carpentry, plastering, painting

Plastering: Replace ceiling and cornice in kitchen/meals, repair/replace/patch plaster throughout house

Tiling to kitchen/meals//laundry: Remove and disposal, carpentry, cement sheet, supply and install approx. 27m2 floor tiles, grout, silicon

Asbestos removal

Meter box

Laundry

Total $X inc GST

Variation 2

Change doors x 5: Flat doors, door handles, hinges, removal and disposal, carpentry, painting, patching, paint prep

Total $X inc GST

Concrete driveway and carport approx. 45m2: Scrap remove old concrete, level, crushed rock, mesh, footing for carport posts

Total $X inc GST

Crush rock backyard (to back fence and side step/landing): Scrap remove old concrete, crushed rock

Total $X inc GST

Front door: Solid door including handle and painting

Total $X inc GST

Remove a/c unit in bedroom

Total $X inc GST

Swap over switches to new in whole house

Tota $X inc GST

Wardrobe in bedroom 2: Remove wall and build new wall to bathroom, new plaster ceiling and cornice, doors x 2 and handles, arks and skirting

Total $X inc GST

Electrical

600 mm raiser bracket/pole,

100A single phase main service fuse box

Total $X inc GST

Back landing/Decking

Replace rotten supports and new pine decking to top landing

Total $X inc GST

No pre-purchase Building Inspection Report was provided

Residential tenancy condition reports completed for tenancies prior to commencement of the building works were not provided

You provided a Residential Tenancy Entry Condition Report for the property undertaken by Agents dated XX/XX/XXXX

You provided a copy of the Market Appraisal undertaken by agents, for the property. The inspection date was XX/XX/XXXX. The document indicates a current market value for rental purposes is $X to $X per week

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 Division 43

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider including:

·         Obtain a scope of works from the builder showing greater detail such as allowing for expenses characterised as repairs and accurately quantify these expenses, and

·         Obtaining evidence of the appearance, form, state and condition of the property and its functional efficiency when the property was initially acquired

You may apply for another ruling on these or any other matters.

Reasons for decision

Summary

A deduction is allowed for the cost of repairs to premises used for income producing purposes. However expenses of capital or of a capital nature are not immediately deductable in the income year you incurred the expenses. In your case, a large portion of the expenditure related to replacement of an entire structure, improvements, renovations and alterations and possibly initial repairs which are expenses of a capital or capital nature. However, you are able to claim deductions over a number of years.

Detailed reasoning

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.

Repairs

Taxation Ruling TR 97/23 provides guidelines on the deductibility of repairs. Generally, a 'repair' involves a restoration of a thing to a condition and efficiency it formerly had without changing its character. Works can be fairly described as repairs if they are done to make good damage or deterioration of property that has occurred by ordinary wear and tear, by accidental or deliberate damage, or by the operation of natural causes during the passage of time

Paragraph 21 of TR 97/23 states that:

What is a 'repair' for the purposes of section 25-10 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.

Repairs must generally relate directly to wear and tear or other damage that occurred as a result of renting out the property. Repairs generally involve a replacement or renewal of a worn out or broken part. Examples of repairs include replacing broken windows, repairing electrical appliances or machinery, replacing part of the guttering damaged in a storm and replacing part of a fence damaged by a falling tree branch.

In your case we consider the following expenses are repairs which brought existing parts to their original state and would be allowable for an immediate deduction under section 25-10 of the ITAA 1997:

·         Supplier - Replacing damaged security screens

·         Supplier - Repair crack in the window glass

·         Supplier - Servicing heater

·         Supplier - re-install air conditioner

·         Supplier - Supply and replace damaged weatherboards and fascia

·         Supplier - Reblocking of domestic building

·         Supplier - Waste disposal

·         Supplier - Roof tiling on rebed and point and safety rail

·         Supplier - External painting of whole house, decking and step oil

Decline in value (Capital Allowances)

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 time it is used (section 40-30 of ITAA 1997)

Depreciating assets are those items that can be described as plant, which do not form part of the premises. These items are usually: separately identifiable; not likely to be permanent and expected to be replaced within a relatively short period and not part of the structure. Examples of assets that deductions for decline in value can be applied to include: timber flooring, carpets, curtains, appliances like a washing machine or fridge and furniture

In your case the following expenses are regarded as depreciating assets for Division 40 of the ITAA 1997 purposes:

·         Supplier - Gas cook top and oven pack, silver dishwasher, slide out rangehood

For each of the assets where you may claim a deduction for decline in value, you can choose to use either the effective life of the Commissioner has determined for such assets, or your own reasonable estimate of its effective life. Where you estimate an asset's effective life, you must keep records to show how you worked it out.

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.

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.

Generally capital works is used to describe certain kinds of construction expenditure used to produce income. Examples of capital works include building construction costs such as: a building or an extension, for example, adding a room, garage, patio or pergola, alternations such as removing or adding an internal wall, or structural improvements to the property, for example adding a gazebo, carport, sealed driveway, retaining wall or fence.

In your case the following expenses are considered capital works:

·         Supplier - Full house renovation and variations

The works undertaken are considered improvements, renovations and alterations which are of a capital nature. There is also the possibility some of the works undertaken were initial repairs to remedy defects, damage or deterioration that existed at the date the property was acquired which would also be expenses of a capital nature.

Bathrooms, kitchen, laundry and carport

The bathrooms, kitchen, laundry and carport are separately identifiable capital 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). The expenditure is regarded as construction expenditure for which a deduction is available under Division 43 of the ITAA 1997.

The costs of the bathrooms, kitchen, laundry and carport are also regarded as an improvement and therefore capital in nature. Therefore the expenses in relation to the bathrooms, kitchen and laundry fit out and the new carport are not deductible as repairs

·         Electrical

Similarly, the electrical work is fixed to the property and is considered to be part of the building. A capital works deduction is allowed for this expenditure being:

-        Supplier - Electrical works re: installation of underground pit (due to repair works)

-        Supplier - Electrical works re: installation of underground pit (due to repair works)

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)

Apportionment

Paragraph 55 to 57 of TR 97/23 covers repairs done at the same time as improvements. The character of a repair does not necessarily change because it is carried out at the same time as an improvement. It is necessary to examine separately the individual parts of the total project to determine whether any part, if considered in isolation, is a repair. If individual parts of the total project can be separated and characterised as repairs, and if their cost can be segregated and accurately quantified, their cost is deductible. It must be possible to segregate the cost of the repairs actually affected from the capital cost of the improvements.

In your case, the Home Improvement Contract and tax invoice from Builder do not segregate, quantify and characterise work as repairs from the capital cost of the improvements.

Apportionment - Initial repairs

Paragraph 59 of TR 97/23 states that:

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.

Paragraph 60 and 61 of TR 97/23 state that 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. Where expenditure remedies damage, defects or deterioration to the property which existed at the time of purchase of the property and did not arise from the income producing activity, the expenditure is not capital in nature.

It is not considered material whether you were aware of the condition or the need for repair of the property at the time of purchase. Expenditure on initial repairs lacks a connection to the income producing activities of the property and is considered an additional cost of acquiring the property or an improvement in the quality of the property your acquired.

In your case we were unable to determine the condition of the property at the time of acquisition as no pre-purchase Building Inspection Report or Residential tenancy condition reports completed for tenancies prior to commencement of the building works were provided. There is a possibility some of the expenditure related to remedying defects, damage or deterioration that existed at the date you acquired the property and not attributable to damage that occurred when the property was rented.