Edited version of private advice

Authorisation Number: 1052324710330

Date of advice: 05 November 2024

Ruling

Subject: Rental property deductions

Question 1

Can you claim a deduction for the cost of the repair work completed on your rental property?

Answer 1

Yes.

You can claim a deduction for the cost of the repair work completed on your rental property under section 25-10 of the ITAA 1997.

Question 2

Can you claim a deduction for the replacement of damaged fixtures as a repair?

Answer 2

No.

The works to remove fixtures, purchase replacements and install them are not deductible as a repair under section 25-10 of the ITAA 1997.

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commenced on:

01 July 20XX

Relevant facts and circumstances

On XXXX you purchased a residential rental property.

You are the sole owner.

The property was made available for rent on XXXX.

The property was managed by a real estate agent who determined the market value of the rent.

During the 20XX financial year it was reported to you by the real estate agent that property fixtures had been damaged

In XXXX you engaged a builder to complete a building inspection (insurance report).

The report noted damage which is creating leakage and water damage to other parts of the house.

You subsequently sought insurance for the repairs but the claim was denied.

In XXXX, you engaged builders to replace the damaged property fixtures.

The building works were completed over a four-week period which coincided with the old tenant vacating the property and a new tenant starting a new rental agreement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 25-10

Income Tax Assessment Act 1997 Division 43

Reasons for decision

Question 1 - Can you claim a deduction for the cost of the repair work completed on your rental property?

Section 25-10 of the ITAA 1997 allows a deduction for the cost of repairs to premises used for income producing purposes. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature. The following are examples of expenses which are capital or of a capital nature:

•                     replacement of an entire structure or unit of property (such as a complete fence or building, a stove, kitchen cupboards or refrigerator)

•                     improvements, renovations, extensions, and alterations, and

•                     initial repairs, for example, in remedying defects, damage or deterioration that existed at the date you acquired the property.

Taxation Ruling TR 97/23 Income tax: deductions for repairs explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction.

TR 97/23 explains that 'repairs' has its ordinary meaning. The term 'repair' ordinarily means the remedying or making good of defects in, damage to, or deterioration of, property to be repaired and contemplates the continued existence of the property. Repair for the most part is occasional and partial. 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.

Repair costs are deductible where they are incurred during the period the property is held for income producing purposes and are attributable either to damage that occurs during your income producing use of the property or to defects that emerge suddenly during that time.

Paragraph 50 of the TR 97/23 explains if the work done restores a previous function to the property, or restores the efficiency of the previous function, it does not matter that a different material is used. Even if the work done using different material enables the property to perform its function marginally more efficiently, the work may still constitute a deductible repair.

In your case, you replaced the original material with another material because of the significant damage. While you used different materials to repair your rental property, the work was done to restore to its original function. The subsidiary part of the building, rather than an asset in its entirety. As it was in a good state at the time you purchased the property, the work done was not an initial repair.

Therefore, you can claim a deduction for the cost of the repair and restoration work completed on your rental property.

Reasons for decision

Question 2 - Can you claim a deduction for the replacement of a damaged fixture as a repair?

Subsection 25-10(1) of the ITAA 1997 states that you can deduct expenditure you incur for repairs to premises (or part of premises) or a depreciating asset that you held or used solely for the purpose of producing assessable income. You cannot deduct capital expenditure under section 25-10.

TR 97/23 provides the principles and the circumstances in which deductions for repairs are allowable.

To repair property improves to some extent the condition it was in immediately before the repair. A minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair. If the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible under section 25-10.

Paragraph 21 of TR 97/23 provides that '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'.

Paragraph 22 of TR 97/23 states:

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. The work may go beyond 'repairs' in terms of the section if it:

(a)          changes the character of the property; or

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

(The cost of this work may be deductible under other provisions of the income tax law, ... Division 43 of the ITAA 1997).

Paragraph 36 of TR 97/23 provides:

Repair is restoration by renewal or replacement of subsidiary parts of a whole. Renewal or reconstruction, as distinguished from repair, is restoration of the entirety.

Entirety

Renewal, replacement, or reconstruction of, the whole or substantially the whole of a thing or structure (entirety) is likely to be considered a capital improvement rather than a deductible repair.

The term 'entirety' is used by the courts in repair cases to refer to something 'separately identifiable as a principal item of capital equipment' (Lindsay v FC of T (1960) 106 CLR 377 at 385; (1960) 12 ATD 197 at 201 (Lindsay)).

In the Lindsay case, the taxpayer company was a slip proprietor and ship repairer. It claimed a deduction for the cost of reconstructing one of two slipways. In finding that the work was not repairs, Kitto J rejected the taxpayer's submission that either the whole slip (comprising the slipway, hauling machines, cradles and winches by which vessels were manoeuvred on to it) or the whole of the business premises containing the slipway should be regarded as the relevant entirety. His Honour decided that the slipway was an entirety by itself and not a subsidiary part of a larger whole.

TR 97/23 details that property is more likely to be an entirety, as distinct from a subsidiary part, if:

•                     the property is separately identifiable as a principal item of capital equipment; or

•                     the thing or structure is an integral part, but only 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 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.

TR 97/23 states that a reconstruction of the whole of property (for example, fencing or a railway) is not a deductible repair. The ruling states:

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

However, if the cupboards are a separately identifiable thing representing an entirety in themselves and the expenditure on replacing the kitchen cupboards results in an improvement or a renewal or reconstruction of an entirety, the expenditure is not a repair but is capital in nature (Taxation Ruling 97/23).

Capital works deductions

Division 43 of the ITAA 1997 provides a deduction for construction expenditure on capital works (including buildings) used for residential accommodation if the construction of the capital works commenced after XX July 19XX and the capital works are used to produce assessable income.

Division 43 applies to capital works that are buildings or structural improvements and to extensions, alterations or improvements to those buildings or structural improvements.

Division 43 of the ITAA 1997 provides that you can deduct an amount for capital works in an income year.

Subsection 43-10(2) of the ITAA 1997 states that you can only deduct the amount if:

(a)          the capital works have a construction expenditure area; and

(b)          there is a pool of construction expenditure for that area;

(c)           you use your area in the way set out in Table 43-140 (current use year).

The deduction can be claimed for 40 years from the date the construction is completed. The rate of deduction per income year is 2.5%.

Capital works also generally include improvements to buildings as stated in subsection 43-20(1) of the ITAA 1997.

In your case, you replaced areas damaged.

This is a separate identifiable capital item with their own function and are, therefore, an entirety in themselves. Their 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 and deductible under Division 43.