Edited version of private advice

Authorisation Number: 1052089646408

Date of advice: 24 March 2023

Ruling

Subject: Rental deductions - capital works

Question 1

Are the expenses relating to the replacement of the garage, at your rental property, deductable under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Are the expenses relating to the replacement of the garage, at your rental property, deductible as capital works under Division 43 of the ITAA 1997?

Answer

Yes.

This ruling applies for the following period:

Income year ended 30 June 20XX

The scheme commenced on:

XX July 20XX

Relevant facts and circumstances

You (Person A and Person B) own a rental property, as joint tenants.

You have owned the property since 20YY and lived in it for X years before renting it out.

The property has been rented out for the last 5 years, since you moved out of the property

You were notified by your tenants of some damage to the garage at the property, via your property manager.

The property manager organised for a builder to inspect the damage and provide a quote on your behalf.

The builder advised a large timber beam on the front fascia of the garage needed replacing, due to safety issues. The other three sides of the garage timber fascia were also starting to age and rot and you were advised that these also needed replacing.

The property manager organised and provided some quotes to fix the damage however, due to the cost of repair, the supplier suggested a whole new garage be installed.

The original roller door was retained as there was no issue with this part of the garage.

You proceeded to replace the garage and received an invoice for a deposit from Company A on XX January 20XX, along with a final invoice for work completed on XX June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Deductions for repairs

Section 25-10 of 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 word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. In W Thomas & Co v. FC of T (1965) 115 CLR 58, it was held that a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. It is the restoration of efficiency in function rather than the exact repetition of form or material that is significant.

Taxation Ruling TR 97/23 Income tax: deductions for repairs deals with the issue of deductions for repairs.

TR 97/23 provides that expenditure for repairs to property is of a capital nature where the extent of the work carried out represents a renewal or reconstruction of the entirety (paragraphs 36-42), or the works result in a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair' (paragraphs 44-58).

Taxation Ruling TR 97/23 states:

•         Works can fairly be described as 'repairs' if they are done to make good damage or deterioration that has occurred by ordinary wear and tear, by accidental or deliberate damage or by the operation of natural causes (whether expected or unexpected) during the passage of time.

•         To repair 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. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10.'

Capital works

Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements and extensions, alterations or improvements to buildings and structural improvements where a residential property is used for income producing purposes. Replacing a roof when only part of it is damaged or renovating a bathroom is classified as an improvement and not immediately deductible. Subsection 43-25(1) of the ITAA 1997 provides that the rate of deduction for capital works which began after 26 February 1992 for a residential rental property is 2.5%.

In Lindsay v. Federal Commissioner of Taxation (1961) 106 CLR 377; held that expenditure incurred to renew a slipway was a renewal of an entirety and was not deductible as a repair under section 53 of the Income Tax Assessment Act 1936 (which was re-written as section 25-10 of the ITAA 1997). This conclusion was drawn on the basis that his honour considered the slipway to be a separately identifiable capital item, maintaining its own function. Substantially the whole of the old slipway had been demolished and replaced by a new slipway, comprising all new components.

Application to your circumstances

The original garage was investigated by a builder, who made a recommendation for repairs to be made. It was then decided that because of the cost that the garage be replaced in full.

As the whole garage was replaced, these changes represent both a renewal or reconstruction of an entirety and an improvement to a fixed capital asset. The replacement of the garage is beyond restoring it to its original state, so therefore your expenditure on replacement of the garage is not deductible under section 25-10 of ITAA 1997, because it is considered to be a capital expenditure.

A deduction is available under the capital works provisions. You are therefore entitled to a 2.5% capital works deduction under Division 43 of the ITAA 1997.