Edited version of private advice

Authorisation Number: 1051918868459

Date of advice: 10 January 2022

Ruling

Subject: Rental - deductions

Question 1

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

•         Repair windows

•         Replace worn front veranda floorboards

•         Plinth boards 160mtrs

•         Fascia boards 60mtrs

•         Labour to remove boards and installation related to items 24, 25 & 26.

Answer

No.

Question 3

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

•         Replace & repoint roof

•         Wash & respray roof tiles

•         Repair and restore front door.

Answer

Yes.

Question 4

Is the cost associated with the gutters and drains deductible as a repair as per section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

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 purchased the property on XX for $XX and you are the sole owner.

The property is a Californian bungalow weatherboard house built around 19XX to 19XX.

Your parent conducted an inspection prior to the purchase of the property. Your parent was satisfied there were no existing defects to the stumps, sewerage pipes and stormwater drainage at the time of purchase.

Neither you or your parent have a background in the building or construction industry.

You did not obtain a building inspection report prior to purchasing the property as you relied on your parent's judgment to assess the property. Your parent inspected underneath the house and did not identify any issues at the time.

The property was purchased at auction and photos were provided to you prior to the purchase which you believed had no pre-existing defects. You have provided a link to photos located on a real estate website showing the condition of the property prior to purchase.

You provided four photos to demonstrate the condition of the property.

The property was genuinely available for rent from settlement date until 20XX. You did not rent out the property after the last tenants vacated as you intended to reside in the property as your main residence.

There was a period in the 20XX financial year where the property was vacant, however the property manager actively looked for another tenant which it was eventually tenanted again.

In 20XX, tenants reported raw sewerage smell coming from underneath the property. It was discovered an old terracotta sewer pipe had broken because a tree root which had grown inside of the pipe.

Your property manager engaged a plumber to remove the tree root from the drain and unblock the drain in 20XX.

You have provided an invoice from the plumber which outlines the following work done to rectify the issue:

• Attend to remove tree roots from a rear section of drain
• Use a sewer machine to clear blockage approx. XX-XXm from the D.T overflow drain.

In 20XX, you identified significant issues with the wooden stumps situated underneath the property. You identified the stumps had rotted and moved, causing pressure on other stumps to move as well.

You engaged a builder and their subcontractors (the builder) to perform both the works and extensive improvements to the property.

The builder advised you the issues with the wooden stumps were most likely due to the poor stormwater drainage and sewer pipes.

You have advised the property had about XX stumps in total, of which XX% were water damaged and needed replacement.

A structural damage report was not obtained as you hired the builder to repair the stumps. They performed an inspection and only provided a basic quote.

You did not obtain a rental inspection report prior to renting out the property to tenants.

You are unable to provide a timeline on when the issues with the stormwater drainage and sewage pipes started and are unable to identify when the issue occurred.

Your parent suspects when the sewerage drain problem was fixed in 20XX, digging and the removal of dirt may have left a passage for stormwater to find its way underneath the house at the high point and traversed to the low point.

You have provided a spreadsheet with a summary of expenses which contains both repair and improvement expenses. You have separately identified expenses from each invoice relating to repairs and classified them into three categories. You have provided invoices and receipts relating to the expenses.

• Re-stumping
• Exterior repairs
• Drains & gutters.

You wish to claim a deduction for the expenses contained in the following tables:

Table 1 - Re-stumping

Table 2 - Exterior repairs

Table 3 - Drains and Gutters

In relation to the re-stumping category, you advised:

• The house was required to be re-stumped, and the bearers were required to be replaced. You only replaced the stumps that were damaged.
• The original stumps were made from wood. The stumps were replaced with a concrete material.
• The floorboards also had to be removed and replaced. The floorboards were originally timber and were replaced with timber. Parts of the living room, corridor/hallway and the two bedrooms had floorboards replaced.
• The plaster for the interior of the property was also required to be re-plastered. You advised all internal walls were re-plastered due to existing damage as well as further damage caused by re-stumping work.
• The interior plaster was made of old lime and sand coated timber. The plaster cracked due to the movement that occurred to the property and parts of the plaster became mouldy and peeled.
• Only the damaged weatherboards were replaced. The lower section of the weatherboards was damaged due to dampness. The old weatherboards were replaced with new weatherboards.

In relation to the exterior repair's category, you advised:

• The process of re-stumping has had a flow on effect and the property had moved slightly to re-align back into place afterwards.
• The re-alignment affected the roof and the front veranda. The roof had become sunk in the middle.
• Some trusses and tiles were replaced on the roof. The roof tiles are terracotta and were replaced with the same material.
• The front door had two wooden and glass panels restored and repaired.
• The window replaced had structural damage to the wood window panel and border. This was replaced with a similar material.
• The floorboards on the front veranda were replaced due to the re-stumping and removal of two pillars at the front of the house. The old floorboards were made of timber and replaced with timber.

In relation to the drains and gutters category, you advised:

• The pipes had cracked underneath the stumps and the drains had blockages that were required to be fixed.
• Work completed to the drainage included removing and changing the discharge points and installing new drainage underneath the house. The downpipes were also replaced.
• The gutters were replaced due to rusting.

Photos received on 20XX by your tax agent show the damage that occurred, and you provided commentary:

•         Image X - shows old veranda and damaged weather boards (bottom left) due to dampness

•         Image X - shows indoor damage to plaster and slanted house/ floor (due to sunken house on that side)

•         Image X - damage to one of the windows that needed to be restored.

You provided an e-mail from your property manager which discusses the condition of the property at the time you advertised for new tenants. The e-mail advises:

•         'The property is in dire need of serious works.'

•         'Several spots of the floor are quite weak especially in the laundry, the main bedroom, and the bathroom. There is also a spot in the kitchen that is quite unsafe.'

•         'The back door is completely insecure, the handle is broken on both sides and the latch is damaged, the only security is the slide bolt, but the frame is so deteriorated that it wouldn't take much to knock in.'

•         'The windows in the sunroom are insecure, the glass and frames are loose.'

•         'There's also a bit of foundation concerns outside, the front and back step and the weather boards down the right-hand side of the house look like they are collapsing.'

•         'A combination of these concerns and the pool being unavailable means people are just walking in and out'

•         'At this stage due to the condition of the house, we have had to cease opens. I would strongly suggest you take a look at the property in person.'

You have provided photos in a document taken by the property manager when the house was advertised for rent the second time. You advised the photos show damage starting to occur to the property.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 Section 110-25

Reasons for decision

Summary

The restumping, some exterior works and work to the gutter & drains undertaken are considered an initial repair to remedy damage, deterioration or defects that existed when you purchased the property, even though you may have not been aware of the issue at the time. Therefore, these expenses are capital in nature and are not deductible under section 25-10 of the ITAA 1997.

The initial repair expenses are not considered capital works expenditure and not deductible under Division 43 of the ITAA 1997. However, the expenses may be included in the fourth element of the cost base of the Property.

Exterior works done in relation to replacing damaged roof tiles/trusses, re-pointing, washing, respraying roof tiles, and replacing panels on the front door does not change the efficiency or the character of the property, does not replace and entirety and is not an initial repair. Therefore, these expenses are considered to be repairs and are deductible under section 25-10 of ITAA 1997.

Detailed Reasoning

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.

The following are examples of expenses which are capital or of a capital 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.

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.

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.

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 (the 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.

Initial repair

Paragraph 59 of TR 97/23 states that expenditure incurred on an initial repair after a rental property is acquired, where the expenses are 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 of the ITAA 1997.

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.

Paragraphs 60 of TR 97/23 state that 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.

Paragraph 61 of TR 97/23 provides it is not considered material whether you were aware of the condition or the need for repair of the property at the time of purchase. It is also immaterial whether the purchase price reflected the need for repairs.

Paragraph 63 of TR 97/23 states an initial repair expense can be dissected or apportioned to allow a deduction under section 25-10 of any part of the expense that remedies deterioration arising from the holding, etc., of the property by the taxpayer for income purposes after it was acquired. No dissection or apportionment is available, however, if the repair expenditure is necessitated by a defect or damage to property because this expenditure is either wholly attributable to the holding, etc., of the property before the taxpayer acquired it or wholly attributable to the holding, etc., of the property by the taxpayer for income purposes after it was acquired.

Expenditure on initial repairs lacks a connection to the income producing activities of the property and is considered an additional cost of acquiring the property or an improvement in the quality of the property you 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 of the ITAA 1997.

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.

The Rental properties 2020 guide provides on page 28 the following examples of construction expenditure:

• a building or an extension, for example, adding a room, garage, patio, or pergola
• alterations, such as removing or adding an internal wall, or
• structural improvements to the property, for example, adding a gazebo, carport, sealed driveway, retaining wall or fence.

If the conditions are satisfied, capital works deductions may be claimed. In the case of residential rental properties, the deductions would generally be spread over a period of 25 or 40 years.

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.

Section 110-25 of ITAA 1997 states that a CGT asset's cost base consists of five elements. You need to add together all these elements to work out your cost base for each CGT asset.

Taxation Determination TD 98/19 Income tax: capital gains: may initial repair expenditure incurred after the acquisition of a CGT asset be included in the relevant cost base of the asset? outlines that initial repair expenditure incurred after the acquisition of a CGT asset is included in the fourth element of the cost base and reduced cost base of the asset.

The fourth element relates to capital expenditure incurred to preserve the value of your asset as per section 110-25(5) of the ITAA 1997. The expenses will be considered when calculating the capital gain or loss on a CGT asset when it is disposed of in the future.

Application to your circumstances

Questions 1, 2, & 4

You have advised your father inspected the property at the time of purchase. Your father was satisfied there were no defects at the time to the stormwater drainage, sewer pipes and stumps.

You have provided background on a previous drainage issue in 20XX when the property was rented. A terracotta sewer pipe was blocked due to a tree root. Your father has speculated the prior sewer pipe issue may have caused subsequent issues and caused damage to the stumps in 20XX.

Your father claims the digging and the removal of dirt may have left a passage for stormwater to find its way underneath the house at the high point and traversed to the low point.

You advised your builder stated the need for re-stumping is most likely due to the poor storm water drainage and sewer pipes. However, neither you or the builder were able to provide a timeline on when the issues with the stormwater drainage and sewage pipes started and are unable to identify when the issue occurred.

You were not able to provide any documentation or reports from a certified building inspector, surveyor, or property manager to verify there were no issues with the stormwater drainage, sewerage pipes, and stumps prior to ownership.

The only third-party written information provided regarding the condition of the property was an e-mail from your property manager in 20XX. Your property manager advised they had foundation concerns with the property. This comment supports the view foundation issues were present prior to you becoming aware of the issues with the stumps in 20XX.

Despite claims from your father suspecting the damage to the stumps arising from the drainage issue in 20XX and comments from your builder, there is not enough written supporting evidence from a certified third-party professional to suggest the issues with the stormwater drainage, sewerage pipes and the stumps were not already present prior to your ownership.

You have advised the property was built around 19XX's to 19XX's. The property is approximately between XX to XX years of age. You had owned and rented the property for approximately XX years before ceasing to make the property available for rent.

Considering the age of the property relative to your period of ownership and the drainage issues which occurred shortly after your ownership, we consider the damage, defects, and deterioration in the re-stumping, some of the exterior works and drains & gutters categories are more likely to have been present prior to your ownership.

We accept you only became aware of the extent of the defects in 20XX and rectified them in 20XX. However, it is irrelevant whether you were not aware of the issue at the time of purchase. It is also immaterial whether the purchase price reflected the condition of the property at the time of purchase.

We acknowledge the issues with the restumping and exterior works categories may have been exacerbated by the re-stumping work conducted in 20XX. However, photos provided by you and comments made by your property manager in 20XX indicate the following damage, defects or deterioration existed at the time of ownership before you became aware of the need to rectify the issues in 20XX.

Weatherboards and foundations

• Photos provided by you shows damage of peeling paint and some weather boards dislodged, particular on the lower parts of the property near the foundations.
• Comments made by your property manager in 20XX regarding foundation concerns outside, particularly the front and back step and the weather boards down the right-hand side of the house look like they are collapsing.

Roof and gutters

• A photo from a real estate website demonstrates rotting on the fascia particularly in the corners of the roof.
• Photos you provided shows the rotting fascia deteriorating for other parts of the roof.
• Photos you provided shows the gutter showing signs of rusting.

Interior walls and plastering

• Photos from a real estate website illustrates outlines of cracks, indicating early signs of cracking on the interior walls in both the lounge room and one of the bedrooms.
• Photos from a real estate website and photos provided by you show the interior walls and plastering with visible, mature cracks appearing in multiple rooms.
• You advised all internal walls were re-plastered due to existing damage as well as further damage caused by re-stumping work.

Interior floorboards

• Photos provided by you indicate extensive damage to the floorboards in multiple rooms with bits of wood from the floorboards chipped off, scratched, not securely in place and mouldy in some of the corners and edges.
• Comments made by your property manager advised several spots of the floor are quite weak especially in the laundry, the main bedroom, and the bathroom.

Windows

• Photos provided by you demonstrate extensive damage to the wooden window frames on multiple windows. Some of the frames had become detached and left the glass unsecured. The wooden frames also show visible signs of rotting.
• Comments made by your property manager advised the windows in the sunroom are insecure, the glass and frames are loose.

Front veranda floorboards

• Photos from a real estate website and photos provided by you show ageing timber with visible discolouration and timber splitting on some floorboards.

Thus, considering the information provided, the Commissioner considers the defects and damage to the restumping, some exterior works and drains & gutters were present at the time the property was acquired in accordance with TR 97/23.

Therefore, these works would constitute an initial repair and you are not entitled to claim deductions under section 25-10 of the ITAA 1997 as initial repairs are capital expenditure or capital in nature.

Consideration was given to whether a capital works deduction contained in Division 43 of the ITAA 1997 may be allowable for any construction expenditure that is not excluded under subsection 43-70(2) of the ITAA 1997.

The restumping, exterior works and drain & gutter works constitutes a repair, not an improvement. The work to the all the defects on the property did not change the nature and character of the house significantly. It is considered all the parts of the property that were repaired, are only part of the house and does not constitute an entirety. The house itself is the entirety.

Based on the information provided and applying the relevant legislation and principles to the facts of your situation, it has been determined that the initial repair expenses are not construction expenditure and not deductible under Division 43 of ITAA 1997.

As the expenses are not deductible immediately or over several years, they may be included in the cost base of the property. 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 1997. It will be taken into account when calculating the capital gain or loss on the property when you dispose of it in the future.

Question 3

Roof

In your case, you conducted re-stumping work in 20XX. The re-alignment of the property when the re-stumping caused repercussions to the tiles on the roof which become damaged and sunk.

Replacing damaged tiles, re-pointing the roof, washing & respraying roof tiles constitutes a repair as it is partly done to remedy or make good of existing defects, damage or deterioration and prevent further deterioration. Work done in anticipation of forthcoming defects or deterioration can be considered a repair where it is done in combination with the rectification work.

Paragraph 40 of TR 97/23 specifically states that a roof is only part of a building and does not constitute an 'entirety'. The building itself is the 'entirety'. Repair work done to the roof is therefore not capital.

Therefore, the replacing damaged tiles, re-pointing the roof, washing & respray roof tiles is not the replacement of an entirety and is not an improvement. Your rental property was used to produce assessable income and as such the costs incurred for the roof are deductible under section 25-10 of the ITAA 1997.

Front door

You replaced two wooden and glass panels restored on the front door. You provided photos of the front door which demonstrates the front door was in good condition at the time of purchase.

The replacement of the panels on the door is not considered to be a replacement of an entirety, not an improvement as you have merely replaced a part of something that is already there and become worn out. Your rental property was used to produce assessable income and as such the costs incurred for the roof are deductible under section 25-10 of the ITAA 1997.