Can the entire amount of these levies be claimed as an immediate deduction as a repair?
No. This ruling applies for the following periods Year ended 30 June 20YY The scheme commenced on: 1 July 20YY
You and your wife purchased the property as joint tenants with a contract date of DDMM20YY. You did not obtain a building inspection report, the property was a mortgagee sale and sold "as is". You did not obtain a pre purchase strata report however the minutes from the 20YY Annual General Meeting (AGM) held on DDMM20YY were provided and consulted. The property settled on DDMM20YY and was immediately made available for rent with a successful tenancy signed on DDMM20YY. On purchase by you, the property was XX years old, in good condition and did not require any immediate repairs to bring it to a rentable condition. The minutes from the 20YY AGM held on DDMM20YY outlined under completed projects, the strata manager discussed completed projects which included apartment XX - rectification of leaks (and resultant damage). During an independent building inspection, various concerns were highlighted within the report being water ingress issues (windows/sliding doors) balustrade (safety issues), balcony waterproofing concerns (tiling) and bathroom waterproofing issues.
The minutes from the 20YY AGM held on DDMM20YY, highlighted in the independent building inspection reported various leaks and subsequent damage to X apartments (apartment XX was not one of those), which was covered by the common property repairs fund. A building consultant advised that some leaks were due to water ingress through windows and sliding doors. Some leaks were also possibly from bathroom wet areas as well as exposed balcony tiling. Under your strata - external windows and doors as well as all hard surfaces including tiling in bathrooms are considered common property and repair costs are shared by all apartment owners. The minutes from the 20YY AGM held on DDMM20YY noted some repairs to the water leak issues had been completed and were to be monitored. The strata manager discussed completed projects which included balcony repairs to apartment XX.
An independent building report highlighted various concerns within the report being balustrade, balcony and wet area waterproofing. The presenter outlined the works required to resolve the water leak issues to various apartments. Based on history and current leaks, it was likely there was not adequate (or any) waterproofing installed to the membrane in the wet areas (bathrooms) or balconies when the building was completed. This is causing major issues to the apartments themselves and the apartments underneath. A qualified independent building inspector (the inspector) was instructed to prepare a fabric report on a specific part of the X apartments (including XX) building fabric used, namely the balcony floors, bathrooms and ensuites, as well as the installation and performance. A site visit Inspection of the four tenancies was undertaken on DDMM20YY. The Fabric report listed the following issues: • Water Ingress • Balcony Balustrade • Remedial work
The minutes from the 20YY AGM held on DDMM20YY show the chairperson delivered a presentation to the meeting in respect of the history of building defects at the complex and extensive works undertaken by the council of owners over the past X years to seek advice and quotes to address these issues. It was unanimously agreed that remedial works to address known waterproofing defects with regards to X apartments (including apartment XX) should proceed as a high priority. These minutes also show you advised you had recent water ingress via the wall cavity which caused damage to the electrical switchboard. A once off reserve levy was proposed to raise $X with your apartment holding contributing $X to be paid on DDMM20YY. The 20YY AGM budget showed $X to be raised for the balcony and bathroom repairs and $X for contingency. The remainder of $X was to be used to pay general repair bills already issued (roof leak, bathroom regrout, etc). On DDMM20YY a tax invoice with a due date of DDMM20YY was issued to you for the once-off Reserve Levy of $X.
On DDMM20YY, you were notified that during a storm part of the complex exterior cladding had separated and fell from height onto the awning and footpath below. The area was made secure and emergency repairs and removal of some cladding was completed. A site inspection was made with a builder offering an immediate temporary solution and repairs as well as a long-term fix. The inspector was instructed to prepare a fabric report on a specific part of the apartments building fabric namely the stone tile cladding having partially fallen away from the façade on to the street. The aim of the report is to discover why this part only of the façade failed and what remedial needs are required. A site visit Inspection of the two tenancies available was undertaken on DDMM20YY. The area beneath the façade in the street had temporary fencing installed. The remains of the stone tiled facade are visibly noticeable from the street and extends four floors including the ground. The Fabric report prepared by the inspector on DDMM20YY, reference is made to the Statement of issues which are outlined as follows: • Cladding failure • Remedial work Future replacement:
On DDMM20YY a tax invoice with a due date of DDMM20YY was issued to you for the special purpose levy as per EGM of $X. The balcony repairs commenced DDMM20YY and are yet to be completed. The bathroom repairs are yet to be started and may not be finished until the next financial year. You have provided information in your email dated DDMM20YY regarding the works. The following information has been provided: • the balcony works scheduled to commence on DDMM20YY and expected to be completed by DDMM20YY have not been completed as planned; there is no expected completion date at this time. • the initial storm damage works were completed on DDMM20YY. • The bathroom works have not commenced.
Income Tax Assessment Act 1997 Section 25-10 Income Tax Assessment Act 1997 Division 43 Income tax Assessment Act 1997 section 43-20
The information provided in relation to the balcony and bathroom works will only be applicable if the works are fully completed by 30 June 20YY. Special levy Under section 25-10 of the ITAA 1997, you can deduct expenditure that 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. However, you cannot deduct capital expenditure under section 25-10. Were the special levies 'incurred' on receipt or payment of the notices? Taxation Ruling TR 97/7 Income tax: section 8-1 - meaning of 'incurred' - timing of deductions (TR 97/7) (paragraph 4) explains that there is no statutory definition of the term 'incurred' for income tax purposes. However, as a broad guide: • you incur an outgoing at the time you owe a present money debt, that you cannot escape (paragraph 5). • an outgoing is 'incurred' if you are 'definitively committed', or 'completely subjected', to the outgoing (subparagraph 6(a)). • the debt must be more than impending or expected. There must be a presently existing liability that is not contingent, or dependent on some other thing (paragraph 18).
Special purpose funds established by body corporates are discussed in Taxation Ruling TR 2015/3 Income tax: matters relating to strata title bodies constituted under strata title legislation (TR 2015/3), which explains that a 'body corporate' is established by the proprietors (paragraph 2) under the strata legislation of the various states and territories. Body corporates may impose levies on proprietors for special purpose funds to meet expenses common to all proprietors. Depending on the nature of the transactions, and weighing a range of factors, these levies may amount to 'mutual receipts'. Relevant factors include: • the relationship between a special levy amount and the common fund. • the purpose for which the payment is made - ie whether the payment is to meet the member's proportion of their mutual liabilities. • the capacity in which an amount is paid - ie whether the member is dealing with the strata title body in their role as a member (TR 2015/3, paragraph 25).
As set out in the facts, you received and paid notices of contribution (notices) from the body corporate that detailed special levies and due dates. The special levies are 'mutual receipts' (refer paragraph 24 of TR 2015/13) that are held by the body corporate for the common benefit of all the proprietors (refer paragraph 67) to undertake the works. The special levies are not 'incurred' on receipt or payment of the notices as you are not definitively committed to debts at that time. There is only an 'expectation' of debts to be paid in the future - when expenses are incurred for the works. The special levies are an estimate of the contribution in respect of your contribution, to the 'expected' mutual liabilities for the works, the mutual works expenses (refer TR 2015/13, paragraph 67). Are the works expenses incurred to date 'for repairs' to property or capital in nature? TR 97/23 provides the Commissioners view regarding circumstances in which expenditure is deductible under section 25 10. Deductions for repairs 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 apartment 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 circumstances in which deductions for repairs are allowable under section 25-10 of the ITAA 1997.
TR 97/23 states that in its context in section 25-10 of the ITAA 1997, the word 'repairs' has its ordinary meaning. It 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. Expenditure to remedy defects, damage, or deterioration in existence at the date of acquisition Initial repair
Paragraph 59 of TR 97/23 states that expenditure incurred on an initial repair after a rental property is acquired, where the expenses are 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 of the ITAA 1997. 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. Paragraph 60 of TR 97/23 states that 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: c) existed at the time of acquisition of the property; and d) did not arise from the operations of the person who incurs the expenditure.
It is not considered material whether you were aware of the condition or the need for repair of the property at the time of purchase. Expenditure on initial repairs lacks a connection to the income producing activities of the property and is considered an additional cost of acquiring the property or an improvement in the quality of the property you acquired. 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 of the ITAA 1997.
Correctly applied waterproofing is expected to last 10 to 15 years. In your case the waterproofing issues came to light just prior to the purchase of your property. The reports provided by the contractor in relation to the balconies, bathrooms and cladding failure have advised that the waterproofing was not applied correctly at the time of construction. As the waterproofing was not applied correctly on construction, remedying that defect is an initial repair and therefore a capital expense. Consequently, the cost is not deductible under section 25-10 of the ITAA 1997. Capital works Division 43 of the ITAA 1997 provides a deduction for capital works. Capital works includes buildings and structural improvements, and also extensions, alterations or improvements to building and structural improvements where a residential property is used for income producing purposes pursuant to section 43-20 of the ITAA 1997. Although an immediate deduction is not available for the special levies in relation to the works for the balcony, bathroom and cladding, a capital works deduction is allowed at the rate of 2.5% each income year while the property is used for income producing purposes.
Application to your circumstances In your case, you acquired the property in MM20YY, by which time the water ingress issues had been identified by the body corporate (independent building inspection MM20YY) and therefore existed prior to your acquisition of apartment XX. As noted in the facts, the property was XX years old when you purchased apartment XX which indicated the property was built in 20YY. You were issued a tax invoice for the once-off reserve levy of $XX in relation to the balcony and bathroom works. As neither of these works have been fully completed you are not yet able to claim any deduction for these works. You were also issued with a tax invoice for the special levy of $XX in relation to the storm damage to the tile cladding on the facade along the street. This was secured as per the engineer's recommendation however a timeline for the permanent facade repairs has not been established.
Division 43 of the ITAA 1997 sets out rules for deductions for capital works. Capital works includes buildings and structural improvements, and extensions, alterations or improvements to buildings and structural improvements where a residential property is utilised for income producing purposes. This special purpose fund was established to cover specific, generally significant expenses not included in ongoing contributions to a general-purpose sinking fund. Most special purpose funds are designated to cover costs related to capital improvements to the common property. Because of this, we treat cladding as: • an entire functional structure (being the outer covering of the building) • an improvement in the function of the outer covering of the building. You are eligible to claim a deduction for the amount you contribute over a period of 40 years from the date the work is complete and the expensed against the funds set aside by the special levy for the work done. Specifically, 2.5% of the cost of the improvement is allowable as a deduction each year.