A taxpayer was recently denied an immediate tax deduction for roof repair and replacement of a rental property because of vermin damage. This ruling is a concise summation for all taxpayers with rental properties assessing the deductibility of large repairs to rental properties
The ATO denied the deduction in the Private Binding Ruling under ITAA 1997 s 25-10 as the repairs were considered “initial repairs”. This was the case even though the property had been owned and rented for a number of years.
This ruling is a concise summation for all taxpayers with rental properties assessing the deductibility of large repairs to rental properties, especially replacements due to structural aspects identified at purchase such as vermin damage. The decision is a good example of the application of Taxation Ruling TR 97/23, which details the ATO approach.
Edited version of ATO written advice in case of rental property “repairs” Authorisation Number: 1013123727436 Disclaimer. Do not use the Register to predict ATO policy or decisions. Date of advice: 15 November 2016
Ruling Subject: Rental repairs.
Question Are you entitled to claim a deduction for removal and replacement of your rental property’s roof as a repair?
Answer No.
Relevant facts and circumstances
You purchased property in 20VV with a settlement date in 20VV.
You have rented this property as an investment property since 20VV.
When purchasing the property you had building inspection and pest inspection reports completed in 20VV with an issue date of 20VV.
Both of these reports advised that vermin damage was identified to the property and recommended to be addressed before acquisition of the property occurred.
The building report advises structural timber pest damage was present to the roof at the time of the inspection and to refer to the pest inspection report.
The pest inspection “Vermin working and/or damage” was found to interior, roof void, trees/stumps and landscaping timbers.
You have since had a pest controller attend the property and treat the house internally for vermin after your acquisition of the property.
The pest controller has also advised that the roof will need to be removed and replaced as well as wall studs, top plates and roof trusses will be required to be replaced during the roof repair and replacement.
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 25-10
Further issues for you to consider
If you have previously claimed deductions for any repairs that were previously identified on the initial building and pest inspection reports, it is highly recommended that you voluntarily lodge amendments for the years claimed and remove these from your income tax returns as you risk your income tax returns being audited and penalties applied.
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. However, subsection 25-10(3) of the ITAA 1997 does not allow a deduction for repairs where the expenditure is of a capital nature.
Initial repairs
Taxation Ruling TR 97/23 explains the principles and the circumstances in which expenditure incurred for repairs is an allowable deduction.
Although the word repair is not defined within the taxation legislation, paragraph 13 of TR 97/23 states that a repair means the remedying or making good of defects in, damage to, or deterioration of property.
Paragraph 15 of TR 97/23 goes further to explain that a 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.
TR 97/23 also states that expenditure to remedy defects, damage or deterioration in existence at the date of acquisition is constituted as initial repairs.
Initial repairs are of a capital nature and not deductible
59. Expenditure incurred on an initial repair after property is acquired, if the expenditure is incurred in remedying defects, damage or deterioration in existence at the date of acquisition, is capital expenditure and is not, therefore, deductible under section 25-10. This is so whether the property is purchased or obtained under lease or licence by the taxpayer. The cost of effecting an initial repair is still not deductible even if some income happens to be earned after acquisition but before the repair expenditure is incurred: but see paragraphs 63 to 66 of this Ruling in relation to dissecting or apportioning initial repair costs.
60. The main consideration in relation to initial repairs is the appearance, form, state and condition of the property and its functional efficiency when it is acquired. Expenditure that remedies some defect or damage to, or deterioration of, property is capital expenditure if the defect, damage or deterioration:
(a) existed at the time of acquisition of the property; and
(b) did not arise from the operations of the person who incurs the expenditure.
61. It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price (or lease rentals) reflected the need for repairs. We consider that the English Court of Appeal decision in Odeon Associated Theatres Ltd v. Jones (Inspector of Taxes) [1972] 1 All ER 681 is not authority in Australia for a contrary view. An initial repair expense is not the type of repair expenditure ordinarily incurred as a working or operating expense in producing assessable income or in carrying on a business. This is because it lacks a connection with the conduct or operations of the taxpayer that produce the taxpayer’s assessable income. It is essentially an additional cost of acquiring the property or an improvement in the quality of the property acquired. Initial repair expenditure relates to the establishment of the profit – yielding structure. It is capital expenditure and is not deductible under section 25-10.
In your case, it is considered that the vermin damage was in existence when you purchased the property. The damage did not occur at a time you held or used the property for an income producing purpose and the work being done to rectify the structural damage made by the vermin is an initial repair and the cost involved is capital expenditure.
Therefore, you are not entitled to a deduction under section 25-10 of the ITAA 1997 for the building work being done on your rental property.
