Edited version of private advice

Authorisation Number: 1051850165600

Date of advice: 14 June 2021

Ruling

Subject: Deductions - legal expenses

Question

Are you entitled to a deduction for the legal costs and rectification costs you incurred?

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 own a residential investment property ('the property').

You rent the property in an arm's length and commercial arrangement.

You arranged for repairs to occur to a retaining wall on the property ('the repairs').

At the time of completing the repairs, the property was tenanted.

While completing the repairs, damage was caused to the neighbouring property's driveway.

The owner of the neighbouring property commenced action against you to recover the costs required to repair their driveway.

As a result of this action, you have paid costs to your neighbour for the repair of their driveway ('rectification costs') and legal costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Section 8-1 of the Income Tax Assessment Act 1997 provides that you can deduct from your assessable income any loss or outgoing that you incur in gaining or producing your assessable income. However, you cannot deduct a loss or outgoing under this provision to the extent that it is capital, private or domestic in nature, or incurred in earning exempt income. For a deduction for legal expenses to be allowed, the expenses must be incidental and relevant to the production of a taxpayer's assessable income and have arisen as a consequence of the taxpayer's income earning activities.

You incurred the legal costs and rectification costs in your capacity as landlord of a rental property. The requirement for you to pay these costs arose out of repairs being completed, to your rental property, to enable you to continue renting the property to the tenant for the purposes of producing assessable income. Therefore, it is accepted that there is a connection between your legal expenses and rental income. As a general principle, it also follows that the treatment of a damages payment, such as rectification costs, will follow the taxation treatment of legal expenses incurred in relation to the particular matter.

In your circumstances, there is a relevant connection between your earning of assessable income and the legal costs. Also, the expenditure did not produce any enduring benefit and consequently is not capital in nature. Therefore, you are entitled to a deduction under section 8-1 of the ITAA 1997 for the legal costs incurred as a result of damage caused to your neighbour's driveway and it follows that the associated rectification costs are also deductible.