Edited version of private advice

Authorisation Number: 1052309935706

Date of advice: 17 October 2024

Ruling

Subject: Rental property deductions

Question 1

Can the legal expenses you incurred in respect to your investment property be claimed as a deduction under section 8-1 of the Income tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

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.

Legal expenses can be characterised as an outgoing on revenue account or an outgoing of a capital nature, depending on the cause or purpose for which the legal expenses were incurred (Hallstroms Pty Ltd v. Federal Commissioner of Taxation (1946) 72 CLR 634; 8 ATD 190; 3 AITR 436). The nature or character of the legal expenses follows the advantage which is sought to be gained by incurring the expenses. If the advantage to be gained is of a capital nature, rather than of a revenue nature, then the expenses incurred in gaining the advantage will also be of a capital nature.

Where legal expenses arise as a consequence of the day to day activities of a business, that is, they are incurred in gaining or producing assessable income, the object of the expenditure is devoted towards a revenue end and the legal expenses are deductible (Herald & Weekly Times v. Federal Commissioner of Taxation (1932) 48 CLR 113; 2 ATD 169).

Accordingly, deductions under section 8-1 of the ITAA 1997 may be claimed by landlord taxpayers for legal expenses that are incidental and relevant to the production of rental income derived.

Question 2

Are damages paid to the tenant, as a reimbursement of their rent, deductible under section 8-1 of the ITAA 1997?

Answer

Yes.

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.

Deductions under section 8-1 of the ITAA 1997 may be claimed by landlord taxpayers for expenses incidental and relevant to the production of rental income derived.

Question 3

Can you immediately deduct expenses you incurred to undertake repairs to damaged and deteriorated parts of your investment property under section 25-10 of the ITAA 1997?

Answer

Yes.

Section 25-10 of the ITAA 1997 permits an immediate deduction for expenditure you incur to repair premises or plant which you hold or use for the sole purpose of producing assessable income; unless the outlay is capital expenditure which is prevented from being deductible as a repair by subsection 25-10(3) of the ITAA 1997.

In your case items 1.1, 3, 4, 5, 6, 7, 8 and 9 are repair expenses which may be deducted immediately under section 25-10.

Question 4

Can you deduct depreciation losses for capital expenditure you have outlaid to repair your rental property under section 40-25 of the ITAA 1997?

Answer

Yes.

Taxation Ruling TR 2022/1 Income tax: effective life of depreciating assets (TR 2022/1) explains a deduction may be available under Division 40 for a depreciating asset's decline in value, to the extent that the asset was held by you at any time during the year and used for a taxable purpose.

The amount you can deduct will be reduced to reflect the extent to which the asset is used for a purpose other than a taxable purpose, e.g. private or domestic purposes or to produce exempt income (section 40-25 of the ITAA 1997).

In your case Items 1.2 and 2 are capital expenses, upon which depreciation losses can be deducted under section 40-25 of the ITAA 1997.

For details on how to calculate allowable depreciation deduction, please refer to the Australian Tax Office's Guide to depreciating assets which is available on the website www.ato.gov.au.

Question 5

Are holding costs, other than repairs, deductible when the property was not rented between March 2024 and July 2024?

Answer

Yes.

Section 8-1 of the ITAA 1997 allows a deduction for any 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.

In this case, the holding costs were incurred in respect of a rental property which was not tenanted for a period of time and no assessable income was produced. The property had been rented prior to the repairs being carried out, with the outlook to rent the property after the repairs were completed.

In your case, the holding costs incurred are not preliminary or of a private or domestic nature. The period of outgoings is not too long as to lose the necessary connection between the outgoing and assessable income and the holding costs are incurred with the view of gaining or producing assessable income. Continuing efforts were made in pursuit of that end.

Therefore, the expenses of holding the property are an allowable deduction under section 8-1 of the ITAA 1997 during the period the property was not tenanted.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commenced on:

1 July 20XX

Relevant facts and circumstances

In MM 20XX, you purchased a property overseas. The property is a flat. The flat is part of a building run by freeholders.

From MM 20XX to MM 20XX, the overseas property was your main residence.

The overseas property was leased to tenants at market rent in the following periods:

•                     MM 20XX to MM 20XX

•                     MM 20XX to MM 20XX

In November 20YY, you received an email from property managers advising that the tenant of the property had been complaining about mould and damp issues in the bedroom and kitchen. The property had no previous history of damp issues.

In MM 20XX, you received a call, email and report from a contractor highlighting mould issues with the property. During this time, you had discussions with the property managers about the ongoing damp issues with the tenant. You approved a full damp survey to identify what was causing the rising damp. You also approved chemical cleaning of the walls to remove the mould.

In MM 20XX, you received a damp report which identified the following:

•                     possible defective plumbing

•                     possible rising damp

•                     possible external drainage issues

In MM 20XX, you had the property external drains surveyed and inspected.

In MM 20XX, you received a report from the plumber which advised that there were no issues found with the drainage system. You also approved your plumber to undertake internal plumbing checks to identify leaks.

In MM 20XX, you received a report from the plumber who attended the property to check the damp issues.

In MM 20XX, the plumber did a pressure test of the pipework and found no leaks. Their report suggested there were signs of rising damp on the outside of the property.

In MM 20XX, you commissioned an agent to issue another damp report to look into the rising damp of the property. During this period, you also received communication from the property managers that the tenant was seeking compensation and a reduction in rent for ongoing damp issues. You also received a quote/report for repairs to resolve damp issues.

In MM 20XX, discussions were held with property managers regarding compensation. No action was taken as there were some questions about whether the damp issue was the responsibility of the body corporate who are freeholders of the building. You issued the damp report/quote to the freeholders of the building for their consideration.

In MM 20XX, you were in communication with the tenant regarding their request for compensation. You advised the tenant of the property that due to the uncertainty about who was liable for repairs, that compensation would not be provided during this period as it may invalidate the freeholders building insurance.

In MM 20XX the following occurred:

•                     the tenant communicated they were going to withhold rent.

•                     the boiler broke down which required replacement.

•                     the oven was reported to be broken and a replacement was required.

•                     you received copies of notices from the Council Environmental officers about their intention to enter the property to conduct a health survey.

•                     you received correspondence from your agent a letter from the tenant's solicitor, serving a claim for preconditions protocol for housing conditions.

In MM 20XX you forwarded the tenants legal claim to the freeholders of the building and request an update as to whether they have been able to inspect and survey property for mould. During this period, you and your agent had several correspondences with the freeholders of the building as per the mould issue.

In MM 20XX, you engaged solicitors to represent and assist you with responding to the legal claim brought forward by the tenant of the property in the hopes to help settle the issue and to avoid a court action.

On DD MM 20XX, you incurred a legal expense of £pound;XX from your solicitors for their professional costs in relation to time spent on your legal claim.

In MM 20XX, the following was reported by the tenant:

•                     leaking tap

•                     issues with the thermostat on the central heating

On DD MM 20XX, you incurred a legal expense of £pound;XX from your solicitors for their professional costs in relation to time spent on your legal claim.

In MM 20XX, further repairs were conducted to the leaking tap and the tenant also reported a panel on a drawer had come off.

In MM 20XX, the tenancy for the tenant was due to end on DD MM 20XX. You had discussions with the property managers about reletting the property. Due to the issues with the property repairs and the legal claim raised by the tenant you decided that viewings would not take place before the tenant had moved out. You decided that in the best interest of your property and the tenant that once they had moved out, repairs would be undertaken to rectify the mould issue and bring the flat back up to standard so it could be re-let. You incurred significant costs with contractors to rectify the rising damp issues and undertake associated repairs.

On DD MM 20XX, you incurred a legal expense of £pound;XX from your solicitors for their professional costs in relation to time spent on your legal claim.

On DD MM 20XX, you incurred a legal expense of £pound;XX from your solicitors for their professional costs in relation to time spent on your legal claim.

On DD MM 20XX, you incurred a legal expense of £pound;XX for the tenant's solicitors cost as a result of an unfavourable court claim outcome.

Your total sum for legal expenses incurred was £pound;XX.

Between the DD MM 20XX and DD MM 20XX, you reimbursed the tenant over several payments £pound;XX and settled the legal claim.

In MM 20XX, the property was repaired and advertised for rent.

In MM 20XX, a new tenant moved into the property.

You incurred the following costs for repairs to the rental property:

•                     Item 1.1 Oven

o        Total sum £pound;XX

•                     Item 1.2 Oven

o        Total sum £pound;XX

•                     Item 2 Boiler

o        Total sum £pound;XX

•                     Item 3 Doors

o        Total sum £pound;XX

•                     Item 4 Heating & Plumbing

o        Total sum £pound;XX

•                     Item 5 Kitchen Draw

o        Total sum £pound;XX

•                     Item 6 Main Bedroom Vents

o        Total sum £pound;XX

•                     Item 7 Damp Issues

o        Total sum £pound;XX

•                     Item 8 Painting and Decorating to make flat ready for new tenants

o        Total sum £pound;XX

•                     Item 9 Pre-Tenancy Works - Repairs

o        Total sum £pound;XX

You incurred the sum of £pound;XX for debit interest as holding costs

You incurred the sum of £pound;XX for body corporate fees as holding costs.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 8-1

Income Tax Assessment Act 1997 Section 25-10

Income Tax Assessment Act 1997 Division 40

Income Tax Assessment Act 1997 section 40-25