Edited version of private advice

Authorisation Number: 1051643713909

Date of advice: 12 March 2020

Ruling

Subject: Rental - deductions - repairs - capital works

Question 1:

Are you entitled to claim a deduction for the costs incurred in relation to the works undertaken on Retaining wall A under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer:

Yes.

Question 2:

Are you entitled to claim a deduction for the costs incurred in relation to rectifying the drainage issues identified the Report on the Retaining wall B under section 25-10 of the ITAA 1997?

Answer:

No. However, a deduction can be claimed for these costs under section 43-20 of the ITAA 1997.

This ruling applies for the following period

Income year ending 30 June 2018

The scheme commences on

1 July 2017

Relevant facts and circumstances

You, being Persons A and B, purchased the Property prior to 20 September 1985 as joint tenants.

The Property was vacant land with a house being constructed on the Property a number of years after it was purchased.

A multi-tiered retaining wall is located along the width of the rear of the Property (Retaining wall A) with another multi-tiered retaining wall located on another side of the Property (Retaining wall B). The tiers in both of the retaining walls are continuous, with each side being the same length.

The Property was first rented out in the year after the house was constructed.

The Property was damaged due to heavy rains in relation to a storm.

An Engineering Report (the Report) was obtained for your insurance company in relation to the damage to the Property which included the following information:

·         the backyard is turfed and shows an erosion rut that leads to a scoured hole just behind the retaining wall.

·         XXX millimetres of rain fell during a short duration, the sheer volume of saturation would have added additional pressure on the wall beyond its intended structural capacity as evidenced by the shearing of the timber post just beside the scour hole. The post has sheared/snapped off at the base of the wall which is the highest stress site.

·         the property is on a slope with the backyard being retained by a multi-tiered timber retaining structure in a terraced configuration that runs the entire width of the property. The wall tapers out towards the back beyond which the terrain is relatively steep and backs into a heavily wooded area.

·         the retaining wall started point for the sheer load. The collapse of this timber post led to the localised failure at other parts of the central wall section, resulting in the formation of the scour hole in the backyard.

·         Retaining wall B beyond the taper appears to be intact and unaffected by the storm but shows signs of weathering due to age. There are flaws in the construction of the wall such as the absence of a filter fabric, cut-off drains at the top of the walls and sub-soil drainage to relieve the pressure build-up from saturation of the backfill. These are risks the owner need to consider

·         repair of Retaining wall A includes:

·         bottom tier panel beside taper

·         installation of two new posts

·         top and middle tier wall

·         remove and replace completely the walls with new timber retaining structure

·         construct concrete spoon drain and install new pre-fabricated pit with piped outlet

·         install new balustrade to match existing balustrade

·         lay top soil to re-turf exposed area

·         reinstate pathway and vegetation to original conditions

·         existing Retaining wall B structure that is to remain in place is weathered, aged and shows onset of deterioration/rot. It is the owner's sole responsibility to ensure that the older sections that remain in place are treated suitably to prolong its life and other landscaping requirements implemented to ensure stormwater runoff is diverted away from the retaining structure; and

·         all reconstruction is to match that of all existing materials.

The Property continued to be rented out during the income year in which the damage occurred.

You received an insurance payout to cover the issues in Retaining wall A as identified in the Report.

Retaining walls A and B had been built a number of years previously and the builder advised that adding another down pipe to the house, cutting down close foliage and putting gutter guards in the gutters should be implemented as preventative measures to ensure that the retaining wall would be able to endure heavy rains and storms.

Originally you had anticipated spending money only on Retaining wall A due to the damage caused by the storm, and the replacing of sections of the retaining wall. You were advised that other sections of the retaining wall, being Retaining wall B, would most likely collapse if maintenance works were not carried out on the entire retaining wall. Additionally, undertaking all of the works at the same time was the cheapest option as the site of the Property posed problems due to its terrain.

You obtained a quote (the Quote) in relation to the works on both Retaining walls A and B which totalled $XX,XXX (Goods and Services Tax inclusive) to undertake the following activities:

You estimate that the invoiced costs related to the following:

·         $X,XXX for the drainage as outlined at Items 6 and 7 in the Quote, which were additional preventative measures

·         $XX,XXX for each of the tiers;

·         $X,XXX for dismantling, storage and reinstatement of the same pavers, plants, post, fence, etc.

The works were undertaken in relation to all of Retaining walls A and B involved the stripping back and removal of the retaining walls, and identifying any parts that could be reused.

Works were also undertaken to Retaining wall B to remedy defects by checking existing timber and removing rotten timber and replacing as necessary, excavating the area and then reinstating all items that could be, such as pavers, plants and timbers. Additionally, drainage issues identified in the Report were rectified.

Materials of a similar type were used to replace any materials that were in the retaining walls prior to the storm.

The title of the Property was put solely into Person B's name during the following income year.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

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.

Generally repairs restore the item to its former function and efficiency. It is acknowledged in TR 97/23 that to repair a 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, 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. Works that are a substantial improvement, addition or alteration will not be a repair and will not be deductible under section 25-10 of the ITAA 1997 and will considered to be capital, or capital in nature.

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.

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 following are examples of expenses which are capital, or are capital in 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 rate of deduction for capital works for a residential property is 2.5% of construction expenditure over 40 years.

Application to your situation

The Property sustained damage to Retaining wall A. A report was obtained, the Report, in relation to the damage to the Property which outlined the works that needed to be undertaken in relation to the Retaining wall A. It also identified defects with the drainage in Retaining wall B and the deteriorating condition of the timber in that retaining wall.

Based on the information provided in the Report, it is viewed that the works undertaken in relation to Retaining wall A were repairs to rectify the damage as identified in the Report. Therefore, a deduction can be claimed in relation to the costs incurred in relation to those works under section 25-10 of the ITAA 1997.

Note: You received an insurance amount to cover the issues in Retaining wall A as identified in the Report. The deduction amount claimed for the costs incurred in relation to Retaining wall A works should be reduced by the insurance amount you received in relation to those works.

The Report identified that there were flaws in the construction of Retaining wall B in relation to its drainage. You estimate that it cost $X,XXX to rectify these drainage issues. As these works were undertaken to improve the function of Retaining wall B in relation to the drainage that had not existed prior to the works being undertaken, they are considered to be an improvement. Therefore, the costs in relation to these works are capital works and a deduction for these costs can be made under section 43-20 of the ITAA 1997.

Matters we have not ruled on

We have not ruled on all of your questions. Here, we list each question that we have not been able to rule on, and explain why.

Question 3:

Are you entitled to claim a deduction for the costs incurred in relation to the other works undertaken on the Western retaining wall at the Property under either sections 25-10 or 43-20 of the ITAA 1997?

Reasons for decision

The Commissioner may decline to make a private ruling decision under subsection 357-105(2) of Schedule 1 to the Taxation Administration Act 1953 where the Commissioner has asked for further information necessary to make the ruling decision and the applicant has not provided that within a reasonable time.

A detailed list of correspondence was provided.

As outlined in the details provided, we have determined that the activities undertaken on Retaining wall B in relation to the rectification of the drainage issue identified in the Report is not deductible as a repair, but is deductible as a capital improvement.

Based on the information provided, we are not able to determine the nature of the other works undertaken on Retaining wall B. We requested additional information in relation to those works to enable us to gain a full understanding of the extent and nature of the works.

While additional information has been provided in relation to the activities undertaken on Retaining wall B, we have not been provided with sufficient information for us to be able to determine with any certainty the exact nature of the activities undertaken on that retaining wall, how much of the retaining wall was affected by the activities, or the extent to which any existing material was used in relation to those activities.

Therefore, we are declining to give you a private ruling in relation to Question 3 because we have not provided with sufficient information we need to make the ruling decision.

Review rights when we have declined to make a ruling

We have declined to make your private ruling, and have given you the reasons. This decision may be reviewable under the Administrative Decisions (Judicial Review) Act 1977 (ADJR).

The ADJR provides you with two main rights.

1.    You can send a written notice to the Commissioner requiring him to provide a written statement of:

·         the findings of material questions of fact

·         the evidence these findings were based upon, and

·         the reasons for his decision.

2.    You can apply to the Federal Court of Australia or the Federal Circuit Court for a review of the decision.

If you decide to apply to the Federal Court or the Federal Circuit Court for a review of the decision, we suggest you seek professional advice on how to progress. In addition, the Court will be able to provide you with some direction and assistance about the process.

An application must be lodged within 28 days of the issue date on your Notice of private ruling.

You may lodge your application for review at the Federal Court or Federal Circuit Court in the State or Territory in which you ordinarily reside, or the State or Territory listed in the address for the ATO shown on your Notice of private ruling.

You can find more information on the Federal Court website fedcourt.gov.au, or the Federal Circuit Court fedcircuitcourt.gov.au