Edited version of private advice

Authorisation Number: 1051743600514

Date of advice: 24 August 2020

Ruling

Subject: Rental property initial repairs

Question 1

Is the cost of restumping the property deductible as a repair as per section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Is the cost of restumping the property to be added to the cost base as an initial repair in accordance with section 110-25 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You acquired the property in XXXX as joint tenants.

The property was built in XXXX.

The property has been rented out at market rates using short term rental accommodation websites such as Airbnb earning assessable income.

You both manage these accommodation requests.

A property inspection report (the report) was performed.

The report provides information in relation to the foundations of the property.

The report has photographs to support the information provided in writing.

In XXXX the kitchen floor was observed to be sinking.

Investigation into the cause of the sinking showed that the entire house had moved, and the foundations would require replacing via a restumping process.

You engaged a contractor to perform the restumping works.

The contractor used concrete and steel stumps as well as additional concrete products to complete the restumping.

The works were not covered by any insurances held on the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 section 110-25

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. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature.

Taxation Ruling TR 97/23 Income tax: deductions for repairs which explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction.

The term 'repair' means the remedying or making good of defects in, damage to, or deterioration of property as long as the restoration is of the entirety and does not change the character of the property. The cost of repairing an income producing property is deductible.

However, TR 97/23 states that expenditure to remedy defects, damage or deterioration was in existence at the date of acquisition is constituted as initial repairs and no deduction is allowable.

59. 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.

60. 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. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:

(a) existed at the time of acquisition of the property; and

(b) did not arise from the operations of the person who incurs the expenditure.

61. 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. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view. 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, property inspection report provides information to support that the damage or deterioration was already in existence at the date of acquisition.

The deterioration of the building which resulted in the repairs would have occurred over a period of time and not just since you purchased the rental property.

Thus, the Commissioner considers the damage was present at the time the property was acquired in accordance with TR 97/23.

Therefore, these repairs would constitute as an initial repair and are not deductable as initial repairs are capital in nature.

Cost base

The cost base of a capital gains tax (CGT) asset is generally the cost of the asset when you bought it. However, it also includes certain other costs associated with acquiring, holding and disposing of the asset.

The cost base of a CGT asset is made up of five elements. You need to add together all these elements to work out your cost base for each CGT asset.

In your case, the expenses incurred for the restumping works are capital in nature. These expenses can be included in the fourth element being a capital cost to preserve the value of your asset as per section 110-25(5) of the ITAA. It will be taken into account when calculating the capital gain or loss on the property when you dispose of it in the future.