Edited version of private advice

Authorisation Number: 1051918136196

Date of advice: 4 November 2021

Ruling

Subject: Rental property - deductions

Question 1

Are the expenses in Table 1 considered repairs and allowable deductions under section 25 of the Income Tax Assessment Act (ITAA) 1997?

Answer

Yes.

As you also lived in the property, you can claim X% of the total amount of these expenses as a rental deduction.

Question 2

Are the expenses in Table 2 considered Capital works under Division 43 of the Income Tax Assessment Act 1997 or depreciable assets under section 40-25 of Income Tax Assessment Act 1997 and eligible to be included in the properties cost base?

Answer

Yes.

As you also lived at the property, you can claim X% of the total amount of these expenses as capital works or depreciable assets as outlined in Table 2. As you have recently sold the property, these expenses will form part of the cost base for capital gains tax purposes.

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

You owned a property (The Property).

The Property was acquired by you in 20XX for $XXX,XXX.

The property has been rented during your ownership period to your sibling and his partner.

You also lived at the Property during your ownership period.

The Property was rented up to 30 June 20XX.

During the year ended 30 June 20XX you derived rental income from the property and this income will be included in your 20XX income tax return.

The rental arrangement is under a lease.

The property was sold in 20XX and the settlement date occurred in 20XX.

The property was sold for $X,XXX,XXX.

You were audited by the Australian Taxation Office (ATO) for the period 20XX to 20XX and the ATO agreed to a percentage to be applied to all rental expenses incurred by you for the property, being X%. This percentage has been applied by you in the years following the audit.

The ATO audit that was conducted during the 20XX to 20XX years settled the rental deductions. This is not considered further in this private ruling.

You have rented out the property (under a lease agreement) since acquisition and returned the rental income in your tax return. You have apportioned the expenditure in respect of the same, between that which is the extent of assessable income and that which was private use.

At the time of purchase, the property was in good condition, clean and well kept. The bathrooms were in good working order at the time of purchase.

In 20XX you also began renting a space from the property to your company. Renovations were undertaken at that time to make an office area. These costs were treated as being on capital account. The income from the rent has been declared in your tax return from 20XX onwards. Any expenses for this part of the property are not considered as part of this private ruling.

In 20XX/XX, Person A also moved into the property and also paid rent. This was also declared as income in your tax returns.

The property has been substantially renovated over the years and most, if not all improvements have been treated on capital account.

In 20XX, major works were undertaken, which included the demolition of the existing kitchen as well as the replacement of all appliances in the kitchen.

In 20XX, further renovations were undertaken with the addition of a garage and theatre. These renovations were treated as capital works.

In 20XX, there was a leak in the shower upstairs, which caused ceiling damage to the middle floor, this was repaired by professionals.

The property consists of X bathrooms.

Two of the bathrooms have been affected by water and asbestos damage. The expenses listed in Table 1 and Table 2 are in relation to these bathrooms.

In August 20XX, one of the bathrooms had a leak. A professional tradesperson detected water under the tiles and therefore the tiles were required to be removed to fix the leak in this area. This meant the demolition of the main bathroom shower used by your sibling and his partner daily. The shower screens and vanity unit were also required to be removed as they were also sitting on and affixed to the tiles.

At this time, you decided not to fix the bathroom due to financial reasons. Your sibling and his partner agreed to use the other bathroom located downstairs. In 20XX, the second bathroom started to leak. Water was also under the tiles.

You do admit that the bathrooms were 'old', and they have been used extensively over the years that you owned the property.

You decided that you needed to sell the property to release equity and some of your debt.

Before you could put the property on the market to sell, you were required to undertake works to the bathrooms.

You have incurred the following expenses in the year ended 30 June 20XX.

You also had gym equipment expenses of $XX and expenses with no invoices of $XXX. These are considered either private expenses or expenses that cannot be deductible without substantiation.

Your bathroom labour expenses totalled $XX,XXX. The invoice does not itemise the specific works undertaken. You will need to determine a reasonable approximation of the works based on capital works and repairs. This will be determined by you after the ruling is finalised.

Your sibling's partner and Person A both agreed to fund some of the expenses provided you pay them back. You have repaid all money owing to them.

Your sibling assisted (at no charge) with budget suggestions to fix the bathrooms and to arrange the tradesman and to ensure the house was back to a condition to present for sale.

Before the work was undertaken in 20XX, the bathrooms were both leaking and one of the frames of the showers had collapsed (broken) and needed to be replaced.

Upon inspection by the builder, it was discovered that one of the bathrooms had asbestos. This had to be removed by law. The asbestos was under the tiles, resulting in the tiles having to be removed to remove the asbestos.

The bathrooms were not remodelled. The photos supplied show that the tiles, vanity units, basins, bath, shower screens were all placed in the same location as was the tiling. These products are an upgrade to what was previously installed in the bathroom.

The builder and plumber can confirm that the leak occurred through the natural use and operation of time.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 40-25

Reasons for decision

Question 1

General deductions

Under section 8-1 of ITAA 1997 you can deduct for losses and outgoings which are incurred in the course of gaining or producing assessable income, unless the losses or outgoings are of a capital, private or domestic nature.

Deductions for repairs

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 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 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.

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.

In your case, the property was rented during the period you incurred the expenses.

We have considered your situation and have determined that the expenses listed in Table 1 are considered repair costs and claimable as a rental deduction. As you also lived in the property, you can claim X% of the total amount of $XX,XXX in the 20XX-XX income year.

Question 2

Expenditure for repairs to property is capital expenditure if the expenditure, rather than being for work done to restore the property by renewal or replacement of subsidiary parts of a whole, is for work that is a renewal in the sense of a reconstruction of the entirety.

Capital works

In some situations, depending on what the expenditure was for, initial repair expenses may be classified as capital works. Capital works is used to describe certain kinds of construction expenditure on buildings, structural improvements, extensions and alterations.

Division 43 of the ITAA 1997 provides a deduction for capital works. Under Division 43 of the ITAA 1997, a deduction for capital works is dependent, among other things, on whether there is 'construction expenditure' for the capital works, which is defined in subsection 43-70(1) of the ITAA 1997 as 'capital expenditure incurred in respect of the construction of capital works'.

Taxation Ruling TR 97/25 Income tax: property development: deduction for capital expenditure on construction of income producing capital works, including buildings and structural improvements addresses a number of matters that are relevant in determining entitlement to, and the amount of, a deduction under Division 43 of the ITAA 1997 in respect of expenditure on the construction of assessable income producing buildings and other capital works. It also identifies certain expenses that are included in construction expenditure.

Paragraph 7 of TR 97/25 outlines the three categories of capital works in respect of section 43-20 of the ITAA 1997 as:

•         Buildings or extensions, alterations or improvements to buildings

•         Structural improvements or extensions, alterations or improvements to structural improvements; and

•         Environment protection earthworks.

In your case, the costs of the work and improvements to the bathrooms in the property are considered capital in nature. Items fixed to the building are considered structural improvements within the definition of Division 43 of the ITAA 1997 and a capital works deduction is allowed.

In your case you have had the entire two bathrooms replaced. The substantial amount of work done to the bathroom in your rental property has increased the value of the property and made the property into a more valuable or desirable state. The replacements of the shower screens, baths and vanities are considered a substantial improvement to the original products that they replace. The extensive amount of work carried out goes beyond being a repair and amounts to an improvement. Therefore, the associated expenses are capital in nature and considered capital works expenditure under Division 43.

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

The carpet and blinds expense listed in Table 2 of $X,XXX can be claimed as a depreciable asset as outlined in section 40-25 of the ITAA 1997.

Therefore, you can claim X% of the total amount of the expenses listed in Table 2 as capital works or depreciable assets. As you have recently sold the property, these expenses will form part of the cost base of the property for capital gains tax purposes.