Edited version of private advice

Authorisation Number: 1051969603702

Date of advice: 5 April 2022

Ruling

Subject: Rental expenses - repairs or replacement

Question

Will the Taxpayer be able to claim a 100% outright tax deduction in relation to the works undertaken on the retaining wall under section 25-10?

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

All legislative references are to the ITAA 1997 unless otherwise stated

Question 1

Will the Taxpayer be able to claim a 100% outright tax deduction in relation to the works undertaken on the retaining wall under section 25-10?

Summary

You are not entitled to an immediate deduction under section 25-10 for the costs you incurred to replace the retaining wall, as these expenses are considered to be capital in nature.

Detailed reasoning

Repairs

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

Taxation Ruling TR 97/23 explains the circumstances in which expenditure incurred by a taxpayer for repairs is an allowable deduction under section 25-10.

The word 'repairs' is not defined in the Income Tax Acts, so will take its ordinary meaning. It ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.[1]

What is a 'repair' for the purposes of section 25-10 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.[2]

Work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense) in property is not in itself a 'repair' unless it is done in conjunction with remedying or making good of defects in, damage to, or deterioration of, property.[3] A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.[4]

Paragraph 32 in TR 97/23 indicates that expenditure for repairs to property is of a capital nature where:

(a)           the extent of the work carried out represents a renewal or reconstruction of the entirety, or

(b)           the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than 'repair', or

(c)            the work is an initial repair.

Entirety

Paragraph 38 in TR 97/23 states:

Property is more likely to be an entirety 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.

Many judicial decisions make it plain that 'repair' involves the making good of defects, damage or deterioration including the renewal of parts and that the word does not imply a total reconstruction.[5]

Application to your circumstances

The boundary retaining wall on your rental property was beginning to lean over you sought advice from relevant government body and engaged a structural engineer.

The engineer's report was conclusive that the retaining wall needed to be replaced in its entirety and you incurred costs associated with the demolition of the existing wall and construction of a new retaining wall.

As set out in Taxation Ruling TR 97/23, the word 'repair' ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.

As the retaining wall was demolished in its entirety and a new wall constructed this is not considered a repair and is of a capital nature. Therefore, a deduction is not available under section 25-10.[6] This concurs with the view expressed in Example 4 in TR 97/23.

While a deduction cannot be claimed for the expenses covered in this ruling under section 25-10, a capital works deduction maybe available under section 43-10, so long as the requirements contained therein are satisfied. However, such a deduction is not allowable where the construction expenditure is excluded under subsection 43-70(2).

Division 43 provides a deduction for capital works and buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. The following are examples of expenses which are capital, or are capital in nature:

(a)           replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)

(b)           improvements, renovations, extensions and alterations, and

(c)            initial repairs, for example, in remedying defects, damage or deterioration that existed at the date you acquired the property.

The rate of deduction for capital works for a residential property is 2.5% of construction expenditure over 40 years.

If those expenses are not deductible under section 43-10, then consideration is to be given to whether the expenses may be included in the cost base of the property.

The fourth element of the cost base pursuant to subsection 110-25(5) allows you to include capital expenditure you incurred where the purpose or the expected effect is to increase or preserve the asset's value or relates to installing or moving the asset.

ATO view documents

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

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 subsection 43-70(2)

Income Tax Assessment Act 1997 subsection 110-25(5)

[1] Paragraph 13 in TR 97/23

[2] Paragraphs 21 and 87 in TR 97/23

[3] Paragraph 14 in TR 97/23

[4] Paragraph 15 in TR 97/23

[5] Paragraph 85 in TR 97/23

[6] Paragraph 43 in TR 97/23