Edited version of private advice

Authorisation Number: 1051901668241

Date of advice: 21 September 2021

Ruling

Subject: Rental - deductions -repairs

Question

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

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Trust purchased an investment property in 20XX.

The property was located in Australia.

The existing building was demolished, and units were constructed in three stages, by a professional home builder.

A retaining wall was constructed due to location of the property.

The retaining wall was constructed before any work commenced and was designed to enrobe and protect the underlying foundations of the building structure.

One unit was retained by the Trust and leased in an arm's length arrangement with an unrelated third party.

In May 20XX the unit sustained damage due to effects of heavy rainfall over a relatively short period.

The damage only affected the Trust's unit, with the portion of the retaining wall situated at the front of the unit, in need of repair.

The deluge of water undermined the cement block wall and caused it to collapse.

Only part of the retaining wall was repaired.

The property was deemed to be unsafe and an engineer determined that the retaining wall and its associated foundations needed to be reinstated to secure the property and make it useable.

The retaining wall was rebuilt using the same materials except for the replacement of some broken blocks and was not changed in any way.

The works undertaken were at a cost of $XX,xxx.xx in the 20XX-XX financial year.

The cost was considerable due to the difficulty in accessing the area that needed repair.

The property was leased in May 20XX at the time of the incident.

The property was income producing in the 20XX-XX financial year when the Trust incurred the cost of repairs.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1997 ('ITAA 1997') unless otherwise stated.

Summary

The Trust is entitled to claim a deduction for the costs incurred in relation to the works undertaken on the retaining wall under section 25-10 of the Income Tax Assessment Act 1997.

Detailed Reasoning

Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to property used for income producing purposes, to the extent that the expenditure is not capital in nature.

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the principles and the circumstances in which deductions for repairs are allowable.

TR 97/23 provides that the word 'repairs' in the context of section 25-10, has its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired and contemplates the continued existence of the property. Repair for the most part is occasional and partial. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

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.

An improvement on the other hand, 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 be considered to be capital, or capital in nature.

Entirety

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.

The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment' (Lindsay v FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201 (Lindsay case)).

In the Lindsay case, the taxpayer company was a slip proprietor and ship repairer. It claimed a deduction for the cost of reconstructing one of two slipways. In finding that the work was not repairs, Kitto J rejected the taxpayer's submission that either the whole slip (comprising the slipway, hauling machines, cradles and winches by which vessels were manoeuvred on to it) or the whole of the business premises containing the slipway should be regarded as the relevant entirety. His Honour decided that the slipway was an entirety by itself and not a subsidiary part of a larger whole.

In the case of WG Thomas & Co Pty Ltd v FC of T (1965) 115 CLR 58; (1965) 14 ATD 78, which involved a claim for general repairs to a building, it was said that the question was not whether the roof or floor or some other part of the building, looked at in isolation, was repaired as distinct from wholly reconstructed, but whether what was done to the floor or the roof was a repair to the building.

Relevantly, paragraph 40 of TR 97/23 describes a building as the entirety, and something that is part of the building, such as a roof or wall is considered to be a subsidiary part rather than the entirety.

Property is more likely to be an entirety, as distinct from a subsidiary part, if:

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

•         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

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

•         the thing or structure is a 'unit of property' as that expression is used in the depreciation deduction provisions of the income tax law.

Application to your circumstances

The property sustained damage to only part of the retaining wall that encompasses the whole of the building structure and it was only this part that was repaired.

In the circumstances, as only part of the retaining wall was repaired, issues in relation to the characterisation of the retaining wall repair as a subsidiary part, or an entirety, do not arise.

The rebuilding of part of the retaining wall restored the property to its original state. The wall was constructed with many of the existing blocks, nothing new was added to the property and the wall was not changed in any way.

The damage sustained in May 20XX was at a time when the property was leased and produced rental income.

The property was again income producing during the 20XX-20XX financial year, at the time the cost of repairs were incurred.

Consequently, the works undertaken in relation to the retaining wall were repairs to rectify the damage at a time when the property had an income producing use. Therefore, a deduction can be claimed in relation to the costs incurred for the works, under section 25-10 of the ITAA.

Conclusion

Based on the information provided, and applying the relevant legislation and principles contained in TR 97/23 to the facts of your situation, it has been determined that the Trust is entitled to claim deductions under section 25-10 of the ITAA 1997 in relation to the retaining wall expenses incurred.