Edited version of private advice

Authorisation Number: 1052251618196

Date of advice: 15 May 2024

Ruling

Subject: Deduction - rental property

Question

Will you be entitled to a repairs deduction under section 25-10 of the Income Tax Assessment Act 1997 for the cost of the replacement of the driveway?

Answer

No.

This ruling applies for the following period:

Year ending 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

You purchased a property at XXXX many years ago.

You have used the property as an income producing investment since you acquired it.

The driveway was in excellent condition when the property was acquired.

The driveway has become dilapidated and is now a safety hazard.

Various concrete contractors advised the driveway is beyond repair.

The advice provided was to completely remove the driveway (entirety) and replace it using the same materials.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

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

Income Tax Assessment Act 1997 Division 43

Reasons for decision

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, 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 construction 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 is not an initial repair or an improvement. However, we must also consider whether the work constitutes a replacement of an entirety.

In Lindsay v. Federal Commissioner of Taxation [1961] HCA 93; (1960) 106 CLR 377 (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 ATOID 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. The expenditure is capital in nature.

Your contentions

You believe that the replacement driveway will not have any improved efficiency or functionality over the existing driveway and therefore it will not be an improvement. Also, the work is necessary for health and safety reasons and to meet current building standards due to deterioration since you first acquired the rental property.

We accept all these points. That is, we do not consider that the replacement driveway will be 'better' than the existing driveway; rather, we accept that it will merely perform the same function as the existing driveway.

However, the replacement of the driveway is the replacement of an entirety which is capital in nature and a capital expense is excluded from being deductible under section 25-10 of the ITAA 1997.

Additional information

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%. In your case, the replacement of the driveway on your rental property is capital works. Consequently, you are entitled to a 2.5% capital works deduction under Division 43 of the ITAA 1997. As a capital works deduction is available, a depreciation deduction is not allowable for the driveway.