Edited version of private advice

Authorisation Number: 1052307787659

Date of advice: 25 September 2024

Ruling

Subject: Deduction for repairs

Question

Will the portion of the special levy raised to finance repairs to the rooftop and facade, basement and other necessary remediation maintenance (excluding replacement of Lift) be an allowable deduction under section 25-10 of the Income Tax Assessment Act 1997 in the year incurred?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

XX/XX/20XX

Relevant facts and circumstances

1.            You are an individual and an Australian tax resident.

2.            You own a unit in an apartment building that you use as a rental property.

3.            In recent years, the area has experienced the wettest year on record and the building has sustained significant water damage to its roof, façade and basement, all of which now requires extensive maintenance and repairs.

4.            Engineering inspection had identified significant water ingress effecting the basement, roof and façade of the building.

5.            Extensive works are required to remediate these issues, many of which will be subsurface drainage works requiring extensive excavation and reconstruction of fill materials, courtyard and creation of new drainage paths. Extensive waterproofing of walls will also be required to protect the garage and hallway area from further water ingress.

6.            The total estimated cost of the repair and maintenance work of the above areas was estimated to be $X which included the cost of replacing the original lift with a new lift which frequently malfunctioned and is no longer repairable.

7.            To finance the estimated cost of the maintenance works, the owners were required pay a Special Levy. You paid two instalments of the Special Levy in the 20XX income year.

8.            A contractor was appointed to carry out the repair work on the roof and façade. The agreed contract price for the work tendered was $X inclusive of GST.

9.            At the completion of the work, the total cost incurred for the repairs and maintenance of the building at the completion of the work amounted to $X (excluding GST). This includes costs for repairs done to roof and façade, new lift replacement totalling $X, and legal fees of $X.

10.          The original lift was entirely replaced with new lift.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 25-10

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

Reasons for decision

1.            Section 25-10 allows a deduction for expenditures incurred by you for repairs to any premises, or part of premises, held or used by you solely for the purpose of producing assessable income. However, a deduction is not allowable if the expenditure is of a capital nature.

Rental property deductions

2.            For a rental property, you can claim a deduction for certain expenses you incur for the period your property is rented or is genuinely available for rent. However, you cannot claim expenses of a capital or private nature (although you may be able to claim decline in value deductions or capital works deductions for certain capital expenditure or include certain capital costs in the cost base of the property for capital gains tax purposes).[1]

3.            You may be able to claim a deduction for body corporate fees and charges you incur for your rental property, as they may be incurred to cover the cost of day-to-day administration and maintenance or for a special purpose.

4.            If the body corporate requires you to pay a special purpose levy for specific capital expenditures, these levies are not deductible until the actual expenditure is incurred. Payments for capital improvements or repairs of a capital nature are also non-deductible. However, if special levies are raised to cover deductible repairs, the levy amounts will be deductible.

5.            The body corporate of your rental property complex has imposed a Special Levy to fund repair significant damage caused by water ingress to the roof, façade and basement of building. If the levy is used to fund deductible repairs, then the levy paid is also deductible. To determine if the special levies raised by your body corporate are deductible, it is necessary to establish whether the repairs are of a capital or revenue nature.

Repairs

6.            To be deductible under section 25-10, expenditure for the repairs must be 'incurred' by the taxpayer in the year of income in which the deduction is claimed. The word 'incur' in section 25-10 has the same meaning as the word 'incurred' in section 8-1. Incurred is not a defined term. However, it does not mean that there must be an actual disbursement of money. It is sufficient if the presently existing liability is due though payable in a future year.[2] Accordingly, a loss or outgoing may be incurred within section 8-1 even though it remains unpaid, provided the taxpayer is 'completely subjected' to the loss or outgoing.[3]

7.            Taxation Ruling TR 97/23 'Income tax: deductions for repairs' (TR 97/23)provides the Commissioner's view on repairs that are allowable under section 25-10 and indicates that expenditure for repairs to property is of a capital nature where:

•                     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 in the property, therefore representing an 'improvement' rather than a 'repair', or

•                     the work is an initial repair.

8.            The term 'repairs' is not defined in the Income Tax Assessment Acts and therefore takes its ordinary meaning. According to TR 97/23 'repairs' 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 and physical sense) and contemplates the continued existence of the property. It involves restoration of the efficiency of function of the property being repaired without changing its character and may include restoration to its former appearance, form, state or condition. A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated. Works can fairly be described as 'repairs' if they are 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. The condition of the property is improved to some extent compared to its state immediately before the repair. [4]

9.            Work done to prevent or anticipate defects, damage or deterioration (in a mechanical or physical sense) in property is not in itself a 'repair' unless it is done in conjunction with remedying or making good defects in, damage to, or deterioration of, the property, e.g., maintenance work.[5]

10.            What constitutes a repair for the purposes of section 25-10 is determined by the facts of each case having regard to the nature and extent of the work done to the property. If work done to property goes beyond what is a 'repair' in terms of section 25-10, any expenditure for the work is not deductible, i.e., where the repair changes the character of the property or does more than restore its efficiency of function of the property.

Roof and building façade works

11.            You have owned a unit in the building for approximately X years and have used the unit to derive rental income.

12.            The work performed on the external façade and walls, roof membrane system and basement of your unit is considered to be a repair as it is to restore the building's original functionality. The work done to in relation to the roof, including the application of new membranes and the extension of capping over the perimeter hob, is also likely to reduce further work being necessary in the future. TR 97/23 states that work done in anticipation of forthcoming defects or deterioration can be considered a repair where it is done in combination with the rectification work. Accordingly, any expenditure in respect to this repair work will be deductible in the income year in which it is incurred.

13.            As the Special Levy you paid is used for repair work on the building, you are entitled to claim a deduction under section 25-10 for the portion of the Special Levy related to repairs on the external façade and walls, roof membrane system, and basement of your rental property. You can claim this deduction in the income year for the portion of the Special Levy corresponding to the expenditure incurred in that year.

Replacement of building lift

14.            According to TR 97/23, expenditure for repairs to property is considered 'capital in nature' if the work being done constitutes a renewal or a reconstruction of the entirety, rather than merely restoring or replacing subsidiary parts of a whole.[6]

15.            Invoices for work done to the lift in the building indicates that a new lift was installed to replace the old malfunctioning lift. If it is considered that the work done to the lift goes beyond what is 'repair' in terms of section 25-10, any expenditure incurred in respect to the lift is not deductible. The work may go beyond 'repairs' in terms of that section if it:

(a)          changes the character of the property; or

(b)          does more than restore its efficiency of function.

16.            A 'repair' is considered capital in nature are where the repair is to an 'entirety' or is an 'initial repair'. The relevant test in your case is whether the work done on the lift is considered to be an 'entirety'.

17.            The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment'.

18.            In Lindsay v. FC of T (1960) 106 CLR 197; 12 ATD 505, the High Court (Kitto J) held that expenditure incurred to renew a slipway was a renewal of an entirety and not a deductible repair. His Honour said at 106 CLR 383; 12 ATD 200:

If the work done in respect of the slipway is correctly described as repairs, it cannot, I think, on the facts of this case, be of a capital nature. The problem is to characterize the expenditure according to the familiar distinction between repair, in the sense of restoration by renewal or replacement of subsidiary parts of a whole, and renewal in the sense of reconstruction of the entirety, meaning by the entirety not necessarily the whole but substantially the whole of the subject matter under discussion: per Buckley L.J., in Lurcott v. Wakely & Wheeler; Rhodesia Railways v. Collector of Income Tax, Bechuanaland'.

19.            Kitto J rejected a submission that the slipway was only a subsidiary part of some larger thing or aggregation of things. His Honour held that the expenditure involved was not deductible under section 53 of the Income Tax Assessment Act 1936 (ITAA 1936) because the slipway ought to be considered as an entirety by itself (at 106 CLR 385; 12 ATD 201):

It is separately identifiable as a principal, and indeed the principal, item of capital equipment, so that in a discussion as to whether work done in relation to it constitutes a repair or a renewal in the opposed senses abovementioned, the subject matter in relation to which the choice of description is to be made is the slipway itself, and not any larger thing or aggregation of things of which it may be suggested to form part.

20.            According to paragraph 38 of TR 97/23, 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.

21.         Subsection 25-10(3) excludes capital expenditure from being an allowable deduction if the work involves reconstructing the entirety of the property, rather than simply renewing or replacing subsidiary parts.[7]

Improvement

22.            Expenditure for work done, if they don't constitute a replacement or reconstruction of an entirety, may still be capital expenditure and not deductible under section 25-10 because it amounts to an improvement.

23.            TR 97/23 sets out the distinction between a repair and an improvement as follows.

44 The meaning of 'repair' or 'repairs' is considered in paragraphs 12 to 30 of this Ruling. In the case of a 'repair', broadly speaking, 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...and it involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life.

45 To distinguish between a 'repair' and an 'improvement' to property, one needs to consider the effect that the work done on the property has on its efficiency of function. This is the determinative test.

46 If the work entails the replacement or restoration of some defective, damaged or deteriorated part of the property, one does not focus on the effect the work has on the efficiency of function of the part. That is not determinative of whether the property is repaired or improved. It is a relevant factor to take into account, however, in considering the effect of the work on the property's efficiency of function. It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property.

47 Replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement.

24.            Paragraphs 48 to 54 of TR 97/23 discusses the use of different materials and technological enhancements. Different materials may be used and still be considered a repair provided it is a restoration of the item's efficiency of function without changing its character.

25.            In many repairs, there is some improvement made to property as a result of technological advancements or the availability of more modern materials and component parts. Generally, the greater the degree of technological advancement used the more likely the work goes beyond repair. Where the degree of technological advancement results in only a minor and incidental improvement and does not change the property's character, it would not generally in itself prevent a deduction under section 25-10.

26.            In your case, the lift is regarded as a separately identifiable principal item of capital equipment. It is attached to the building, and although it is not used independently of the building to generate any income, it functions as a separate and distinct unit from the structure it serves. The lift is an integral part, but only a part, of entire building and is capable of providing a useful function without regard to any other part of the building. Therefore, the lift is the entirety in itself and not a subsidiary part of the building.

27.            Given the age of the building, it is reasonable to assume significant deterioration of the lift over time, which was further accelerated from damage caused by water ingress through the basement walls leading to the lift shaft.

28.            The lift itself is approaching the end of its useful life and it is not unexpected that its function diminishes due to worn out mechanical components. The lift frequently malfunctioned and required constant repairs, eventually reaching a point where it was beyond repair.

29.            Work on the lift involved dismantling and removing the original lift and installed a completely new lift. Technical specifications of the new lift indicates that it has a larger load capacity and enhanced with digital and monitoring technology and modern finishes with stainless steel hairline. Accordingly, the expenditure incurred in relation to the replacement of the lift are not deductible under section 25-10.

30.            Additionally, no deduction can be claim for legal expenses incurred. These legal expenses were identified as being of a capital nature and are therefore not deductible under section 25-10.

[1] QC 72633 - Rental Properties Guides 2023.

[2] Taxation Ruling TR 94/26 - Income Tax: subsection 51(1) - meaning of incurred - implications of the High Court decision in Coles Myer Finance.

[3] Taxation Ruling TR 94/26 - Income Tax: section 8-1 - meaning of 'incurred' - timing of deductions.

[4] Paragraphs 13 and 16 of TR 97/23.

[5] Paragraphs 14 and 19 of TR 97/23.

[6] Paragraph 32(a) f TR 97/23.

[7] Paragraph 32(b) of TR 97/23.