Rental Properties – Deductible Repairs v Capital Improvements Posted on October 9, 2018
Deductible repairs
Repairs to premises are deductible under s 25-10 ITAA 1936 to the extent that they are held or used for the purpose of producing assessable income. To be deductible, the repairs must relate directly to wear and tear or other damage that occurred as a result of renting out the property.
Note: s 25-10 does not require the taxpayer to own the property, merely to use it in producing assessable income. This means that a lessee can claim deductible repairs when the lessee incurs the expenditure.
The Commissioner examines the work ‘repairs’ in TR 97/23, stating that it has its ordinary meaning, i.e., the remedying or making good of defects in, damage to, or deterioration of, property (being defects, damage or deterioration in a mechanical and physical sense) and contemplates the continued existence of the property.
The Ruling makes the following comments with respect to repairs:
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A repair involves restoration of the efficiency of function of the property being repaired without changing its character;
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It includes restoration to its former appearance, form, state or condition;
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A repair merely replaces a part of something or corrects something that is already there and has become worn out or dilapidated; and
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Repairs 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.
Examples include:
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replacing part of the guttering or windows damaged in a storm;
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replacing part of a fence damaged by a falling tree branch;
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repairing electrical appliances or machinery.
The Ruling states that work done to prevent or anticipate defects, damage or deterioration is not in itself a ‘repair’ unless it is done in conjunction with a repair.
Maintenance
‘Maintenance’ is work to prevent deterioration or fix existing deterioration. The Ruling states that work done to property not in need of repair is not repair work and any expenditure for the work in these circumstances is not deductible under s 25-10. However, it states that some kinds of maintenance work are ‘repairs’, including painting plant or business premises to rectify existing deterioration and to prevent further deterioration.
The Ruling states that oiling, brushing or cleaning something that is otherwise in good working condition are not ‘repairs’. However a deduction may be permitted under s 8-1.
Ongoing v initial repairs
The cost of repairing defects, damage or deterioration in existence at the date of acquisition of property is not deductible. It is capital expenditure and is therefore disallowed by s 25-10. This is the case even if income is earned by the time the repair is conducted.
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Example from ‘Rental Properties 2011-12 – claiming repairs and maintenance expenses’ Stephen needed to do some repairs to a rental property he recently purchased before the first tenants moved in. He paid tradespeople to repaint dirty walls, replace broken light fittings and repair doors on two bedrooms. He also had to have the house treated for damage by white ants. Because Stephen incurred these expenses to make the property suitable for rental, not while he was using the property to generate rental income, the expenses are capital expenses. This means he cannot claim a deduction for them.
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Note that these expenses may be eligible for capital works deductions, or may be included in the cost base of the asset for CGT purposes
Restoration v improvement
TR 97/23 acknowledges that to repair property improves to some extent the condition it was in immediately before repair. However, if the work amounts to a substantial improvement, addition or alteration, it is not a repair and is not deductible. The Commissioner considers that a minor and incidental degree of improvement, addition or alteration may be done to property and still be a repair.
The Commissioner considers that an ‘improvement’ provides a greater efficiency of function in the property. It involves bringing a thing or structure into a more valuable or desirable form, state or condition than a mere repair would do. The following factors may point to work done being an improvement include:
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whether the work will extend the property’s income producing ability;
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whether the work will significantly enhance the property’s saleability or market value; or
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whether the work will extend the property’s expected life.
Replacement or substantial reconstruction of the entirety, as distinct from the subsidiary parts of the whole, is an improvement (see below).
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Example from ‘Rental Properties 2011-12 – claiming repairs and maintenance expenses’ Tim replaced a fibre cement sheeting wall inside his property with a brick feature wall because it was damaged by tenants. The new wall is an improvement because Tim did more than just restore the efficient function of the wall. This means Tim cannot claim the cost of the new wall as a repair. However, had Tim replaced the fibro with a current equivalent, such as plasterboard, he could have claimed his costs as a repair. This is because it would have merely restored the efficient function of the wall without changing its character, even though a different material was used.
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Replacing of part v entirety
If a repair replaces something in its entirety, the expense will be capital in nature and non-deductible. TR 97/23 states that property is more likely to be an entirety if:
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it is separately identifiable as a principal item of capital equipment;
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it 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;
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it is a separate and distinct item of plant in itself from the thing or structure which it serves; or
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it is a ‘unit of property’ as that expression is used in the depreciation deduction provisions.
Property is more likely to be a subsidiary part rather than an entirety if:
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it is an integral part of some larger item of plant; or
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the property is physically, commercially and functionally an inseparable part of something else.
For example:
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replacement of a whole fence rather than replacing damaged palings would be considered capital expenditure and non-deductible;
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replacement of a stove, kitchen cupboards or a refrigerator is not a repair.
However, in the above circumstances, a capital allowance deduction may be available.
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Example from ‘Rental Properties 2011-12 – claiming repairs and maintenance expenses’ Janet has owned and rented out a residential property since 12 January 1983. Recently she replaced the old kitchen fixtures, including the cupboards and appliances. The old cupboards had deteriorated through water damage and wear and tear. The kitchen cupboards are separately identifiable capital items with their own function. This means the cost of completely replacing them is a capital cost. Because of this, Janet can only claim a: · capital works deduction for the construction cost of this work · deduction for the decline in value of the kitchen appliances. This is the case regardless of whether or not any of the following apply: · new fittings are of a similar size, design and quality as the originals · new cupboards are made from a modern equivalent of the material used in the originals · layout and design of the new kitchen may be substantially the same as the original.
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The cost of replacing items such as locks and exhaust fans, which are permanent fixtures installed in rental property is deductible as a repair under s 25-10 provided it is a replacement of a worn out unit by a new unit of a similar design that simply restores its efficiency of function and is not an improvement (see TR 97/23).
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Important Where the repair amounts to capital, then the expenditure should be considered for: · whether a decline in value deduction may be available (Division 40 ITAA 1997) · whether the taxpayer may be eligible for a capital works deduction (Division 43) · whether the expenditure can be included in the fourth element of the cost base (i.e., capital expenditure incurred to increase or preserve the asset’s value – s 110-25(5)) |
