Edited version of private advice

Authorisation Number: 1052238102411

Date of advice: 16 April 2024

Ruling

Subject: Deductions - rental property expenses

Question 1

Are the cost of restoration works to the Property, aside from those relating to the pool fence, deductible as repairs under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in the income year or years incurred?

Answer

Yes, to the extent that the Taxpayer is able to separately segregate the cost associated with the repairs from the improvement made to the pool fence on a reasonable basis. Where the cost of repairs cannot be separately segregated and accurately quantified independently from the cost of the improvement, we regard the cost of the entire work as being of a capital nature and not deductible under section 25-10 of the ITAA 1997.

Question 2

Are the costs of replacing the pool fence of the Property deductible as repairs under section 25-10 of the ITAA 1997 in the income year or years incurred?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 2022

Income year ended 30 June 2023

Relevant facts and circumstances

1.   The Taxpayer owns the Property that consists of a house made of weatherboard timber and a pool.

2.   The Property is heritage listed with restrictions on what works can be carried out.

3.   The Taxpayer purchased the Property in 19XX.

4.   The Taxpayer repainted the house around 20XX and installed a pool, together with a pool fence, in or around 20XX.

5.   The Taxpayer used the Property as their main residence until 20XX and thereafter, for private purposes until July 20XX.

6.   The Property has been used for income producing purposes from July 20XX.

7.   Prior to the works being undertaken during the 20XX income year, the condition of the Property was as follows (as described by the Taxpayer):

Table 1: Prior to the works being undertaken during the 20XX income year, the condition of the Property was as follows (as described by the taxpayer)

8.    The Taxpayer carried out, or arranged to carry out, the following restoration works (in accordance with the relevant heritage law guidelines):

Table 2: The taxpayer carried out, or arranged to carry out, the following restoration works (in accordance with the relevant heritage law guidelines):

9.   The works were collectively undertaken and completed at various stages during the 20XX and 20XX income years:

•         painting commenced in late April 20XX and was completed in May 20XX;

•         the pool fence replacement commenced in late April 20XX and was completed in July 20XX; and

•         window repairs commenced in May 20XX and were completed in June 20XX.

10.         After the restoration works, the Property was restored to its original appearance.

Relevant legislative provisions

Income Tax Assessment Act 1997 Division 8

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 8-5

Income Tax Assessment Act 1997 section 8-10

Income Tax Assessment Act 1997 section 12-5

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 subsection 25-10(1)

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

Income Tax Assessment Act 1997 Division 43

Income Tax Assessment Act 1997 section 43-1

Income Tax Assessment Act 1997 section 43-15

Income Tax Assessment Act 1997 section 43-20

Income Tax Assessment Act 1997 subsection 43-20(2)

Income Tax Assessment Act 1997 subsection 43-20(3)

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

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

Reasons for decision

Summary

The restoration works in respect of the interior and exterior walls, weatherboards and windows of the Property are considered to be repairs and therefore allowable for immediate deduction under section 25-10 in the income year in which the Taxpayer incurred costs relating to those works.

The replacement of the pool fence of the Property is not a repair but better characterised as an improvement. Consequently, the cost of the replacement of the pool fence is not immediately deductible under section 25-10, however it is deductible as capital works under Division 43.

Detailed reasoning

Section 8-1 provides a taxpayer with a deduction for a loss or outgoing to the extent to which it is incurred in gaining or producing your assessable income. A loss or outgoing is not deductible under section 8-1 to the extent that it is of a capital, private or domestic nature.

Section 8-5 also allows a taxpayer to claim a deduction under a provision of the ITAA 1997 other than the general deduction provisions in Division 8 (called a specific deduction).[1]

Relevantly, subsection 25-10(1) provides a taxpayer with a deduction for 'repairs' where the repairs are made to premises or a depreciating asset held or used solely for the purpose of producing assessable income.

Where a deduction is allowed in 2 or more provisions of the ITAA 1997 in respect of the same amount, that deduction must be claimed under the provision that is most appropriate (section 8-10). Paragraph 7 of Taxation Ruling TR 97/23 Income tax: deductions for repairs (TR 97/23) states that, where a deduction is allowable in both sections 25-10 and 8-1, the most appropriate provision under which to claim a deduction is section 25-10.

Expenditure incurred for repairs is not deductible to the extent that it is of a capital nature (subsection 25-10(3)). There are 3 main categories of non-deductible capital expenditure in the context of subsection 25-10(3). These are:

•         expenditure on improvements;

•         expenditure on additions and alterations; and

•         expenditure on initial repairs.

Repairs

The word 'repairs' is not defined in the ITAA 1997, and thus takes on its ordinary meaning. In W Thomas & Co Pty Ltd v FCT[2], Windeyer J said that 'Repair involves a restoration of a thing to a condition it formerly had without changing its character.'

Paragraph 13 of TR 97/23 explains the term 'repairs' in its ordinary sense:

[Repairs] 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 or physical sense) and contemplates the continued existence of the property.

Determining whether a work done is a repair involves a question of fact and degree, having regard to the appearance, form, state and condition of a particular property at the time the expenditure is incurred and to the nature of the work done to the property (paragraphs 21 and 87 of TR 97/23).

Maintenance work - whether 'repair'

Paragraph 19 of TR 97/23 states that:

Work done partly to remedy or make good defects, damage or deterioration does notcease to be a repair if it is also done partly - even largely - to prevent or anticipate defects, damage or deterioration... in property or in rectifying defects in their very early stages. Repairs are not confined to rectifying defects, damage or deterioration that have already become serious.

Repair is distinct from improvement

In distinguishing repairs from an improvement, the 'effect that the work done on the property has on its efficiency of function' must be considered (paragraph 45 of TR 97/23).

Paragraph 44 of TR 97/23 explains the difference between a repair and improvement:

... In the case of a 'repair'... the work restores the efficiency of function of the property without changing its character. An 'improvement'... provides a greater efficiency of function in the property - usually in some existing function. It involves bringing a thing or structure into a more valuable or desirable form, state or condition that a mere repair would do...

Entirety

To the extent that a repair done to the property involves a renewal or replacement, it is necessary to determine whether that repair is in relation to a part only of an asset (deductible under section 25-10) or whole of an asset (non-deductible capital works). That distinction was considered in Lurcott v Wakely & Wheeler[3] where Buckley LJ stated that:

Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal, as distinguished from repair, is reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole subject matter under discussion. (emphasis added)

The term 'entirety' has been commonly used by courts in repair cases to refer to something 'separately identifiable' as a principal item of capital equipment.[4] In ascertaining whether the repair relates to a part only of an asset or the whole of an asset turns on each fact of the case.

Some indicia that provide guidance on whether a property is likely an entirety or a subsidiary part are set out in paragraphs 38 and 39 of TR 97/23:

38. 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.

39. Property is more likely to be a subsidiary part rather than an entirety if:

•         it is an integral part of some larger item of plant; or

•         the property is physically, commercially and functionally an inseparable part of something else.

Repairs done at the same time as improvements

Where repairs are carried out at the same time as improvements, the costs in relation to repairs are deductible to the extent that they can be segregated and accurately identified.

Paragraph 56 of TR 97/23 states:

[If] repair work is inextricably bound up with work of an improvement nature, and the repair work cannot be separately segregated and its cost accurately quantified independently from the cost of the improvements, we regard the cost of the entire work as being of a capital nature and not deductible.

Capital Works

Where a repair expenditure is not immediately deductible under section 8-1 or under a specific deduction provision (i.e. section 25-10) because of its capital nature, the repair works may be deductible under Division 43.

Division 43 provides a taxpayer with a deduction for certain capital expenditure on assessable income producing building and other capital works (section 43-1).

Section 43-20 sets out the specified capital works to which Division 43 applies. They include structural improvements, or extensions, alterations or improvements to structural improvements (subsection 43-20(2)). Examples of structural improvements are set out in subsection 43-20(3) and include, amongst other things, sealed roads, sealed driveways, sealed car parks, sealed airport runways, bridges, pipelines, lined road tunnels, retaining walls, fences, concrete or rock dams and artificial sports fields.[5]

The amount that a taxpayer may deduct is a portion of its construction expenditure (section 43-15). Subsection 43-70(1) defines 'construction expenditure' to mean a capital expenditure incurred in respect of the construction of capital works (including indirect costs[6]). However, pursuant to subsection 43-70(2), construction expenditure does not include expenditure on:

• acquiring land;
• demolishing existing structures;
• clearing, levelling, filling, draining or otherwise preparing the construction site prior to carrying out excavation works;
• landscaping;
• plant; or
• property or expenditure for which a deduction is allowable, or would be allowable if the property were to be used for the purpose of producing assessable income under another specified provision of the Income Tax Assessment Act 1936 or ITAA 1997.

Application to the Taxpayer's circumstances

Interior and exterior walls

The paint on the interior and exterior walls of the property exhibited signs of deterioration (i.e. mould stains and peeling) and water damage from previous tenancy which necessitated the need for restoration (Case J47).[7]

Certain maintenance works such as painting business (or income producing) premises to rectify existing deterioration and prevent further deterioration are considered repairs as contrasted from maintenance works that involve oiling, brushing or cleaning something that is otherwise in good condition.[8]

As such, the repainting of the interior and exterior walls of the property is a deductible repair under section 25-10.

Pool fence

The Taxpayer replaced the entire pool fence with identical timbers and reinstalled them in its original position.

In order for the repair work to be deemed an allowable deduction under section 25-10 (that is, not be of a capital nature), the replacement of the pool fence must be regarded as a replacement of a subsidiary part and not the whole of an asset.

In weighing the factors set out in paragraphs 38 and 39 of TR 97/23, the pool fence is likely to be an entirety as it is capable of providing a useful function without regard to any other part of the premises. Pool fences are primarily used as safety barriers to prevent children from accessing the pool unattended. The pool fence could not be reasonably expected to serve other significant functions other than being an enclosure around the pool.

The pool fence is a stand-alone structure that is not fixed or attached to any part of the house (cf. Samuel Jones & Co (Devondale) Ltd v Commissioner of Inland Revenue).[9] Therefore, it is unlikely to be a subsidiary part because it is not physically, commercially and functionally an inseparable part of something else.

Where a repair work involves a replacement of the entire fence rather than restoring damaged sections of it to good condition, the replacement will not be deductible under section 25-10 as it would be deemed as a reconstruction of the entirety (see Example 4 at paragraphs 165 to 167 of TR 97/23). Paragraph 47 of TR 97/23 supports that proposition stating that 'a replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement'.

The replacement of the pool fence is an improvement and not a repair. It is of a capital nature and therefore it is not immediately deductible under section 25-10. However, the Taxpayer is able to claim the cost for the replacement of the pool fence as a capital works deduction under Division 43.

Weatherboards

The weatherboards (in poor condition) were replaced with the same timber as the original in compliance with the requirements of the relevant regulatory body.

The use of identical timber materials would restore the weatherboards in its original condition without changing its character and/or efficiency of function.

The extent of the work is nothing more than merely replacing a part of something or corrects something that is already there and has become worn out or dilapidated.[10] As such, the replacement of the weatherboards is a deductible repair under section 25-10.

Windows

The window frames were repainted and reinstalled in their original position using new hinges. There were no changes to the windowpanes.

The use of new hinges could not be said to have increased the efficiency of the window's functions.

The windows are also less likely to be an entirety as they are physically, commercially and functionally an inseparable part of the house.[11] Paragraph 40 of TR 97/23 states that 'something that is part of a building... is just that and no more. The building itself is the entirety.'

As such, the replacement of the window frames is a deductible repair under section 25-10.

It is noted, however, that the invoices obtained by the Taxpayer from the contractor do not segregate or accurately quantify the repair cost relating to the weatherboards and windows from the pool fence replacement. To claim immediate deductions under section 25-10 in the income year or years incurred, the Taxpayer should obtain an accurate breakdown of costs from the contractor in respect of the repair works to the weatherboards and windows.

[1] Rules that apply to specific deductions are set out in the table under section 12-5.

[2] (1965) 115 CLR 58 at 72.

[3] [1911] 1 KB 905 at 924.

[4] Refer to Lindsay v FCT (1961) 106 CLR 377 at 358. See also paragraph 37 of TR 97/23.

[5] Refer also to the document titled 'Rental properties 2023' which outlines a list of deductible capital works expenditures relating to rental properties, accessible at: ATO Rental Properties 2023.pdf, page 26.

[6] Paragraph 13 of Taxation Ruling TR 97/25 refers to 'indirect costs', in the context of construction activities, as costs that cannot be, by means of accounting records or documentations, allocated to an individual element of a construction project, such as a building or a plant.

[7] (1958) 9 TBRD 244.

[8] TR 97/23, paragraphs 20 and 92.

[9] (1951) 32 TC 513.

[10] TR 97/23, paragraph 15.

[11] TR 97/23, paragraph 39.