Edited version of private advice

Authorisation Number: 1052228185062

Date of advice: 7 March 2024

Ruling

Subject: Deduction - legal expenses

Question

Can you claim legal expenses as a deduction under section 8-1 of the Income Tax Assessment Act 1997?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 2023

Year ending 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

You own a property (the property).

You have used the property to earn assessable income for several periods since 20XX.

You are currently using the property to earn assessable income.

You had some issues with the bathroom at the property that required attention.

The issues leading up to the need for works to be carried out on the bathroom included the following:

•         leaking plumbing,

•         cracked tiles,

•         holes in plasterboard,

•         waterproofing issues,

•         black mould.

You are including capital works deductions for bathroom works undertaken in your income tax returns.

Your rental agreement with the tenants at the time the need for bathroom works was identified lapsed.

The property was vacant from that point.

Renovations to the bathroom commenced soon after.

Renovations were completed the following month.

The entire bathroom was gutted and a new bathroom installed.

You had an inspection conducted by a building surveyor. He completed a condition report following the inspection.

The report stated that as the building works were not completed in accordance with the relevant building code, the works were considered illegal building works

You subsequently placed the property on the market for sale.

It was taken off the market several months later when you discovered that the bathroom did not meet Australian standards and could therefore not be sold.

The property was thenrented out with the agreement to lapse in a few months time.

Shortly after the lease commenced, a site inspection was undertaken following your concerns that the bathroom works were not up to the required Australian standards.

Remedial works are now required to ensure that the bathroom complies with the required Australian standards. These works include removing tiles and flooring and waterproofing the bathroom.

You have spent an amount on legal expenses in taking action against the builder who installed the bathroom to have them carry out remedial works.

A conciliation hearing is scheduled. If the issue is not resolved at that point, you will proceed to the relevant court for resolution.

Remedial work to the bathroom to ensure it complies with the relevant building standards has not been undertaken yet.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Reasons for decision

Summary

You cannot claim your legal expenses as a deduction under section 8-1 of the Income Tax Assessment Act 1997?

Detailed reasoning

Section 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that you can deduct from your assessable income any loss or outgoing that you incur in gaining or producing your assessable income.

However, you cannot deduct a loss or outgoing under this provision to the extent that it is capital, private or domestic in nature.

For a deduction for legal expenses to be allowed, the expenses must be incidental and relevant to the production of a taxpayer's assessable income and have arisen as a consequence of the taxpayer's income earning activities.

Legal expenses are characterised as an outgoing on revenue account or an outgoing of a capital nature, depending on the cause or purpose for which the expenses were incurred (Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634; (1946) AITR 436; 8 ATD 190)

As outlined in Herald & Weekly Times Ltd v Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169, where an enduring benefit is gained from the expenditure, the expenditure will be treated as being an outgoing of capital nature.

Application to your circumstances

The initial work carried out to the bathroom at the property was capital in nature. You are claiming capital works deductions in your income tax returns accordingly.

As outlined in Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23), expenditure incurred for works to property will be capital in nature where the extent of the work carried out represents a renewal or reconstruction of an entirety.

You gained an enduring benefit when you renovated the bathroom at the property. The expense incurred was to preserve the income earning 'structure' of the property. The expenditure also represents a renewal or reconstruction of an entirety as above. Such expenditure is treated as an outgoing of a capital nature.

As the capital works do not meet the required standards, remedial works need to be undertaken to the bathroom. You have incurred legal expenses in your attempt to have the works carried out.

You have incurred the expenses in producing your assessable income. However, the expenses relate to an outgoing of a capital nature, being the initial renovation of the bathroom. As a result, the amounts are not deductible from your assessable income.

Although you cannot claim your legal expenses as an immediate deduction, you can include them in the cost base of the property for capital gains tax purposes.