Edited version of private advice

Authorisation Number: 1052213550966

Date of advice: 23 January 2024

Ruling

Subject: Rental property deductions

Question 1

Is the taxpayer entitled to claim the following expenses they incurred for work carried out on their rental property, due to tenant damage, as repair deductions under section 25-10 of the ITAA 1997?

•         Restoring electrical wiring and circuit board

•         Plastering of walls and ceilings from physical and water damage

•         Painting after repairs

•         Repair to grout and taps in bathrooms

•         Balcony repair

•         Carpentry repairs to beams

•         Plumbing works

•         Manhole repair

•         Heating ducts

•         Pool punctures and structural damage

•         Draught proofing on doors and windows

•         Replace stained and eroded tiles from chemicals

•         Kitchen stone bench top

•         Bath replacement

•         Replace built in wet bar

•         Door frame

•         Glass in ensuite

•         Sliding tracks in wardrobe

•         Properties thermal glazing - water and chemical damage

•         Custom built in cabinetry

No. Based on the information provided to the Commissioner the expenses the taxpayer incurred on their rental property are not deductible as repair expenses under section 25-10 of the ITAA 1997.

However, a deduction is allowable, at 50% of the taxpayer's share, for the expenses under section 43-10 of the ITAA 1997 which provides a deduction for capital expenditure on capital works used to produce assessable income.

Question 2

Is the taxpayer entitled to claim the following expenses they incurred on their rental property, due to tenant damage, as repair deductions under section 25-10 of the ITAA 1997?

•         Removal of water damaged carpet

•         Replace floor coverings - carpet, floorboards, overlay flooring to affected areas

•         Replacement of ducted heating unit

•         Replacement of blinds

•         Replacement of air conditioning units

•         Chandeliers

•         Fridges

•         Table

•         Dining chairs

•         Lounge suite

•         Mexican oven

•         Leather sofa bed

•         Beds

•         Futon day bed

•         Futon wool mattress

•         Mattresses

•         Pendants - lighting

•         Buffet unit

•         Entertainment units

•         Chest of drawers

•         Antique wardrobe

•         Antique cupboard

•         Antiques bedside tables

•         Lamps

•         Treadmill

No. Based on the information provided to the Commissioner the expenses the taxpayer incurred on their rental property are not deductible as repair expenses under section 25-10 of the ITAA 1997.

However, a deduction is allowable, at 50% of the taxpayer's share, for the expenses under section 40-25 of the ITAA 1997 for depreciating assets, as they have a limited effective life.

Question 3

Is the taxpayer entitled to claim the following expenses they incurred for work carried out on their rental property, due to tenant damage, as repair deductions under section 25-10 of the ITAA 1997?

•         Bean bags

•         Rugs

•         Mat

•         Children's toys

•         Rug runner

•         Ski clothes

•         Doonas

•         Bed covering - mattress protectors, pillows, sheets, duvets, throws and decorative pillows

•         5 x suitcases

•         Vintage wines

No. Based on the information provided to the Commissioner the expenses the taxpayer incurred on their rental property are not deductible as repair expenses under section 25-10 of the ITAA 1997.

As the items were replaced in their entirety as they were not able to be repaired, a deduction is allowable, at 50% of the taxpayer's share, under section 8-1 of the ITAA 1997.

Question 4

Is the taxpayer entitled to claim the following expenses they incurred for work carried out on their rental property, due to tenant damage, as repair deductions under section 25-10 of the ITAA 1997?

•         Waste clean-up and removal

•         Waste disposal and cleaning of pool during repairs

•         Replacing locks after being changed by tenants

•         Repairs to windows and locks

•         Landscaping works for repair of damage to front and rear yards

•         Flyscreen

•         External damage to windows from being sealed

•         Temporary repair to air conditioner

Yes. Based on the information provided to the Commissioner the expenses the taxpayer incurred on their rental property are deductible as repair expenses at 50% of the taxpayer's share under section 25-10 of the ITAA 1997.

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

The taxpayer has a rental property.

The property was purchased in 20YY at a price of $000,000.

The taxpayer is an equal joint owner of the property with their spouse at 50% each.

The property was first made available to rent in 20YY.

In the 20YY- and 20YY- income year, the property was rented on an online platform via an agent.

The property was available for rent for the 20YY- and 20YY-income year until MM 20YY when it was damaged by tenants who used the property for illegal purposes.

The taxpayer provided a police report stating that the police attended the property on DD MM 20YY. The police observed up to 10 rooms containing cannabis plants, black plastic sheeting on the floors and walls and containers of liquid fertiliser.

The taxpayer provided a video showing the cannabis plants in pots, irrigation in the halls and rooms, lights installed above the plants in the halls and rooms, additional timber construction to hold plants, containers of chemicals in bathrooms which included in the bathtub, many electrical leads and wiring in cupboards, along walls and ceilings, furniture overturned in halls and rooms and heating/cooling ducts on floors and ceilings.

In the 20YY- and 20YY-income year, the property was briefly rented out to friends for a reduced rate as they were overseeing the repairs while the taxpayer was living and working in another state. The property was not fully restored until MM 20YY It was not made available for rent after that due to an ongoing dispute with the platform online provider for insurance.

At the time of the damage in 20YY, the property was managed by an agent.

When rented out in the 20YY- and 20YY-income year, the rental charge was calculated using the online platform provider algorithms.

From 20YY until 20YY, the property was not rented out as it was undertaking major repairs due to the tenant damage.

From 20YY until 20YY, the property was rented out at the negotiated reduced rate to friends overseeing the repairs.

From 20YY until 20YY, the taxpayer was finalising the repairs fit out.

From 20YY until 20YY, the property was unrented due to an ongoing legal dispute with the online platform provider.

The property has been rented again since 20YY.

The taxpayer stayed in the property from 20YY until 20YY finalising repairs.

The taxpayer stayed again in the property for two weeks in 20YY to ensure compliance with their insurance that it wasn't vacant for too long.

All expenses have been jointly paid by the owners of the property.

The property was recently renovated prior to rental and repairs are only to restore it like for like.

The damages were to the home (brick), garden, pool (vinyl) and contents (multiple).

There is an ongoing legal dispute with the online platform provider as they have not reimbursed the taxpayer with owners' insurance in relation to this damage.

The taxpayer provided supporting documents that details the works done on the home prior to renting.

The taxpayer provided photos of the property prior to the damage.

The taxpayer provided documents and depreciation schedules showing works and renovations completed prior to renting the property.

The taxpayer advised that some items such as the wine and ski clothes were in a locked cupboard and not for tenant use.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 subsection 25-10(3)

Income Tax Assessment Act 1997 section 40-25

Income Tax Assessment Act 1997 subsection 40-30(1)

Income Tax Assessment Act 1997 subsection 40-45(2)

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 subsection 40-80(2)

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 43-10

Income Tax Assessment Act 1997 section 43-75

Income Tax Assessment Act 1997 section 43-85

Income Tax Assessment Act 1997 section 45-40

Income Tax Assessment Act 1997 subsection 43-25(1)

Income Tax Assessment Act 1997 section 43-30

Income Tax Assessment Act 1997 subsection 43-70(1)

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

Reasons for decision

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.

Subsection 25-10(3) of the ITAA 1997 precludes 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. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710 (Thomas' Case), 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 Income tax: deductions for repairs (TR 97/23) explains the circumstances in which expenses incurred by a taxpayer for repairs are allowable as a deduction under section 25-10 of the ITAA 1997. What is a 'repair' for the purposes of section 25-10 of the ITAA 1997 is a question of fact or degree in each particular case.

TR 97/23, at paragraph 15, explains that a repair for the most part is occasional and partial. A repair merely replaces a part of something that is already there and has become worn out or dilapidated. Work carried out can fairly be described as a 'repair' if 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.

TR 97/23 also explains that expenditure for repairs 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 provide a greater efficiency of function in the property, therefore representing an 'improvement' rather than a 'repair' (paragraphs 44-58).

An 'entirety' is defined as something 'separately identifiable as a principal item of capital equipment' (Lindsay v. Federal Commissioner of Taxation (1960) 106 CLR 377; (1960) 12 ATD 197; (1960) 8 AITR 710).

In Thomas' Case, the High Court, when considering deductions claimed for repairs to guttering, roof, walls and two floors of a building, took the view that the whole building was the entirety. In this case, Windeyer J said that the relevant question is not whether the roof or floor, looked at by itself, was repaired as distinct from being reconstructed or replaced. It is whether the roof or floor was a repair of the building.

TR 97/23, at paragraph 55, explains the character of a repair does not necessarily change where an improvement is also carried out at the same time. If some part of a particular job can be identified, separated and considered in isolation as an improvement, then the rest of the work done may still be repairs.

Work carried out on a rental property goes beyond being a 'repair' if it changes the character of the property or does more than restore its efficiency and function. Generally, if the degree of improvement involves renewal or replacement of more than a subsidiary part, or the degree of improvement is more than minor and incidental, the 'repair' expenses are of a capital nature and not deductible under section 25-10 of the ITAA 1997.

Decline in value

Section 40-25 of the ITAA 1997 states that you can deduct an amount for the decline in value of a depreciating asset you hold to the extent that you use it for a taxable purpose. The term 'depreciating asset' is defined in subsection 40-30(1) of the ITAA 1997 as an asset that has a limited effective life and can reasonably be expected to decline in value over the time it is used.

However, subsection 40-45(2) of the ITAA 1997 provides that Division 40 of the ITAA 1997 does not apply to capital works to the extent that an amount is or could have been deductible under Division 43 of the ITAA 1997 (capital works).

Under subsection 40-80(2) of the ITAA 1997, an immediate deduction for certain non-business depreciating assets costing $300 or less can be claimed providing the asset cost less than $300; it is used mainly for the purpose of producing assessable income; it is not part of a set of assets that cost more than $300; and it is not one of a number of identical or substantially identical assets which together cost more than $300.

Section 8-1 of the ITAA 1997 allows a deduction for all losses and outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income, or a provision of the ITAA 1997 prevents it.

Capital works

Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to buildings and structural improvements.

A rental property is a building to which Division 43 of the ITAA 1997 applies.

Section 43-10 of the ITAA 1997 requires that:

• The capital works has an area in which capital works is carried out, the work is begun after 30 June 1997, and the expenditure incurred is for capital works that are owned or leased by the taxpayer (section 43-75 of the ITAA 1997)

• There is an amount of construction expenditure incurred that is attributable to the capital works area (section 43-85 of the ITAA 1997), and

• The construction area must be used in a deductible way at some time during the year of income for the purposes of producing assessable income.

Expenditure on items that form part of the structure of a rental property, such as water pipes, bathroom fittings, and light fittings that are wired to the building are considered structural improvements within the definition of Division 43 of the ITAA 1997. These expenses are incurred for items that do not go beyond being part of the setting of an income producing operation. The items form a permanent part of the fabric of the building and are not considered plant within the definition of section 45-40 of the ITAA 1997.

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%. However, a deduction cannot be made prior to the completion of the capital works (section 43-30 of the ITAA 1997).

Section 8-1 of the ITAA 1997 allows a deduction for all losses or outgoings to the extent to which they are incurred in gaining or producing assessable income except where the outgoings are of a capital, private or domestic nature, or relate to the earning of exempt income.

To the extent' incurred in gaining or producing your assessable income

Taxation Ruling, TR 2020/1 Income tax: employees: deductions for work expenses under section 8-1 of the Income Tax Assessment Act 1997 explains in the following paragraphs when expenses require apportionment in relation to producing assessable income.

Paragraph 37, The use of the phrase 'to the extent' in section 8-1 means that expenses may be deductible only in part if incurred in gaining or producing assessable income as well as for some other use, object or purpose.

Paragraph 38, in these circumstances, it is appropriate to apportion expenses between their income-producing, and other, elements. In cases where there is no obvious method of apportionment, it is to be done on a 'fair and reasonable' basis. What is fair and reasonable depends on the particular facts and circumstances relating to the expense.

Paragraph 39, A common approach for employee expenses is time-based apportionment between work-related and private use of an expense item.

The negative tests

Paragraph 41, even if an expense meets the positive test, a deduction cannot be claimed if it fails one of the negative tests. The negative tests are whether an expense is:

•         capital or capital in nature

•         a private or domestic expense

•         incurred in gaining or producing exempt income.

Conclusion

In this case, the taxpayer rented their property, fully furnished, for the greater part of the 20YY income year until MM 20YY when it was discovered that extensive damage occurred to large areas of the interior, exterior (including gardens and pool) and to the furnishings of the property due to tenant damage from illegal activities. The extent of the damage was so severe that the property was uninhabitable until a large amount of the items damaged had been repaired or replaced. The property was rented out for a short period of time to friends, for an agreed amount, to oversee the repairs between MM 20YY and MM 20YY.

Due to the above extent of damage and legal proceedings, the Commissioner accepts that the property would have either been rented or available to rent for the whole of the 20YY income year if the property was in a tenantable condition.

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.

You will still be considered to hold a rental property for income purposes at the time of the repair even if it is vacant at that time if you will rent out the property again when the repairs are complete.

Question 1

As explained above, the replacement of various items as per question 1, constitutes the renewal of an entirety as they form part of the structure of a rental property, making the taxpayer's expenditure capital in nature. A deduction under section 43-10 of the ITAA 1997 is based on the amount of construction expenditure. This is defined in subsection 43-70(1) of the ITAA 1997 as capital expenditure incurred in respect of the construction of the capital works.

Paragraph 43-70(2)(e) of the ITAA 1997 excludes expenditure on plant from construction expenditure.

The role and function of the item's replacements in relation to the income producing activities (i.e. renting your property) do not go beyond being part of the setting of an income producing operation when they are installed in a residential rental property. As a result, the replacement items are not plant. Therefore, expenditure on the items at question 1 are expenditure for which a deduction is available under section 43-10 of the ITAA 1997.

Question 2

The total costs incurred, for the items in the above question 2, are not deductible as repair expenses under section 25-10 of the ITAA 1997.

However, a deduction is allowable for these costs under section 40-25 of the ITAA 1997 as the items at question 2 are depreciating assets within the definition of subsection 40-30(1) of the ITAA 1997: they have a limited effective life and can reasonably be expected to decline in value over the time they are used in the rental property.

Question 3

TR 97/23 explains at paragraph 7 that at section 8-10 of the ITAA 1997 provides a rule against double deductions. If expenditure on repairs is potentially deductible under both sections 25-10 and 8-1, section 8-10 provides that you can deduct only under the provision that is most appropriate. Which provision is the most appropriate is an objective question. In our view, if both sections 25-10 and 8-1 allow you to deduct the same amount, section 25-10, being the provision that deals specifically with repair expenditure, is the most appropriate provision.

The expenses incurred for items at the above question 3 are for items that were damaged by the tenants and were not able to be repaired. As the items were replaced in their entirety and not repaired, a deduction is allowable under section 8-1 of the ITAA 1997.

You explained that some items at question 3 were not for tenant use but locked away for your personal use, example: ski clothing, wine.

You will need to work out the amount of the expense that relates to your income-producing activities, if any of the following apply:

•         your property is only genuinely available for rent for part of the year

•         you use your property for personal purposes for part of the year

In TR 2020/1 paragraphs 37, 38, 39 and 41 discuss when it's appropriate to apportion expenses incurred between income-producing, and other, elements.

As some items were only used for personal use, not tenant use, these items (wine, ski clothing) and the suitcases, which have the appearance of being used for personal use by the taxpayer and would not have been used by the tenant, will not be an allowable expense as they are not items used for the purpose of earning assessable income.

If you use the rental property and items within the property at any time for personal use, you will need to apportion the expenses incurred between the tenant use and personal use (where you are not earning assessable income). This will also include expenses incurred at other questions in this ruling where necessary.

Under subsection 40-80(2) of the ITAA 1997 considers the application of deductions and whether a claim can be an immediate deduction, costing less than $300, an asset costing over $300 where an immediate deduction is not allowable and/or part of a set. The cost of the expenses will need to be considered when making a claim.

Question 4

As per TR 97/23, at paragraph 15 above, the items at question 4 were expenses you incurred to restore the efficiency or function of the item, without changing its character. In your case, the repairs of the items at question 4 are an allowable deduction under section 25-10 of the ITAA 1997 as repair expenses.

Note: If any expenses claimed as a deduction have been covered by insurance claims, these claims would no longer be allowable deductions to the extent that they have been 'reimbursed'. You may need to do an amendment and an adjustment balance in your return if this occurs after lodgement.