Edited version of private advice

Authorisation Number: 1052186371124

Date of advice: 27 October 2023

Ruling

Subject: Rental deductions

Question 1

Are you entitled to a repairs deduction for the costs incurred for the replacement of the driveway?

Answer

No.

Question 2

Are you entitled to a capital works deduction at the rate of 2.5% per year for the costs incurred for the replacement of the driveway, apportioned for the income year?

Answer

Yes.

This ruling applies for the following period:

Year ended XX XX 20XX

The scheme commenced on:

XX XX 20XX

Relevant facts and circumstances

You purchased an investment property in XX 20XX.

It has been rented since the purchase date.

Tenants at the property advised that the driveway was slippery, and therefore dangerous.

In XX 20XX, the driveway was cleaned, and non-slip additive was applied.

The driveway continued to be slippery.

You had 2 options, either to resurface the driveway or to replace the driveway.

In XX 20XX, you replaced the driveway.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Summary

The replacement of the driveway is a replacement of an entirety and therefore capital in nature. Consequently, you are not entitled to a repairs deduction for this expenditure under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997). However, it is capital works for which you are entitled to a capital works deduction at the rate of 2.5% per year under Division 43 of the ITAA 1997. The 2.5% capital works deduction will have to be apportioned for the 20XX-XX income year as you had the replacement driveway installed partway through that income year.

Detailed reasoning

Repairs

Section 25-10 of the ITAA 1997 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.

The word repair is not defined within the tax legislation and takes its ordinary meaning. Repair involves a restoration of a thing to a condition it formerly had without changing its character (W Thomas & Co Pty Ltd v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710).

Expenditure for repairs is of a capital nature where:

•         the work is an initial repair

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

•         the work results in a greater efficiency of function, therefore representing an improvement rather than a repair.

Taxation Ruling TR 97/23 Income Tax: deductions for repairs explains the circumstances in which deductions for repairs are allowable. 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. The ruling further states that repairs mean the remedying or making good of defects in, damage to, or deterioration of, property. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated.

TR 97/23 states that with a repair, the work restores the efficiency of function of the property without changing its character. An improvement, on the other hand, provides a greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable or desirable state or condition than a mere repair would do.

It is acknowledged in TR 97/23 that 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. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997.

It is accepted that the work in question in your case was not an initial repair and was not an improvement. However, we must also consider whether it constituted a replacement of an entirety.

In Lindsay v. Federal Commissioner of Taxation (1961) 106 CLR 377; [1961] HCA 93 (Lindsay's Case), the High Court (Kitto J) 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 and was a renewal of a separately identifiable item and not a repair.

The Commissioner considered the issue of replacement of an entirety in the rental property context in ATO Interpretative Decision 2003/222 Income Tax Repairs: replacement of kitchen cupboards in a rental property. In that ATO ID, damaged kitchen cupboards in a rental property were replaced. The Commissioner considered that the cupboards were a separately identifiable thing representing an entirety in themselves. Consequently, their replacement constituted a replacement of an entirety and was capital in nature. Therefore, the expenditure was not deductible as a repair under section 25-10 of the ITAA 1997. However, the Commissioner considers that kitchen cupboards are capital works which are eligible for the 2.5% capital works deduction. As a capital works deduction is available, a depreciation deduction is not allowable (subsection 40-45(2) of the ITAA 1997).

The principles from Lindsay's Case and ATO ID 2003/222 equally apply here. The driveway is a separately identifiable capital item with its own function and is, therefore an entirety in itself. The replacement is a renewal of an entirety and the expenditure is not deductible as a repair under section 25-10 of the ITAA 1997 as the expenditure is capital in nature.

Capital works

Division 43 of the ITAA 1997 provides a deduction for capital works used for income producing purposes. 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% per year.

Subsection 43-20(3) of the ITAA 1997 specifically includes a sealed driveway as capital works for the purposes of Division 43 of the ITAA 1997. Consequently, you are entitled to a capital works deduction at the rate of 2.5% per year for the replacement driveway. The 2.5% capital works deduction will have to be apportioned for the 20XX-XX income year as you had the replacement driveway installed partway through that income year. As a capital works deduction is available, a depreciation deduction is not allowable for the driveway.