Are you entitled to claim the expense you incurred for work carried out on your rental property's retaining wall as repair deduction under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
No. The costs that you incurred for replacing your retaining wall are not deductible as a repair under section 25 -10 of the ITAA 1997. You replaced the original timber retaining wall with steel and concrete. This is an improvement as the steel and concrete is a significant upgrade of materials from the timber, making it better than it was before and more efficient. However, a deduction is allowable for the expenses under section 43-10 of the ITAA 1997 which provides a deduction for capital expenditure on capital works used for the purpose of producing assessable income. You will need to apportion this for the time that you leased out your room during the income year and by the percentage of the property that was used for income producing purposes. This ruling applies for the following period : Year ending 30 June 20XX The scheme commenced on: 1 July 20XX
You are the sole owner of a property. Timber retaining walls were installed around the property prior to your purchasing. During storms and heavy rain, the soil and land had moved around the property. Due to time and weather, the timber retaining walls began to rot, crack and move away from the supporting posts, therefore not supporting the ground behind them. Your insurance does not cover damage to retaining walls due to storms, heavy rain or flooding. On X/X/20XX you incurred the cost of $0 to replace parts of the retaining wall within the property. You replaced the retaining wall with concrete sleepers and metal posts. During the income year ending 20XX, you leased out a room of the property for 48 weeks with 50% use of the common areas.
Income Tax Assessment Act 1997 section 25 -10 Income Tax Assessment Act 1997 Division 43
Repairs 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. Subsection 25-10(3) of the ITAA 1997 precludes a deduction for repairs where the expenditure is of a capital nature. The word 'repair' is not defined within the taxation legislation. Accordingly, it takes its ordinary meaning. In W Thomas & Co v. Federal Commissioner of Taxation (1965) 115 CLR 58; (1965) 14 ATD 78; (1965) 9 AITR 710 (Thomas' Case) , it was held that a 'repair' involves a restoration of a thing to a condition it formerly had without changing its character. It is the restoration of efficiency in function rather than the exact repetition of form or material that is significant. Work carried out on a rental property goes beyond being a 'repair' if it changes the character of the property or does more than restore its efficiency and function. Generally, if the degree of improvement involves renewal or replacement of more than a subsidiary part, or the degree of improvement is more than minor and incidental, the 'repair' expenses are of a capital nature and not deductible under section 25-10 of the ITAA 1997.
Taxation Ruling Income tax: deductions for repairs (TR 97/23) explains the circumstances in which expenses incurred by a taxpayer for repairs are allowable as a deduction under section 25-10 of the ITAA 1997. What is a 'repair' for the purposes of section 25-10 of the ITAA 1997 is a question of fact or degree in each particular case. Repairs are ordinarily undertaken with like for like materials or modern equivalents. Where a different or more valuable material is used it changes the state of the thing which is subject to damage and will not generally be a repair. If the work amounts to a substantial improvement (an upgrade), addition or alteration, it is not a repair and is not deductible under section 25-10 of the ITAA 1997. Paragraph 42 of TR 97/23 details that, although something is not reconstructed or replaced in its entirety, it may still be capital expenditure and not deductible under section 25 -10 because it amounts to an improvement.
Paragraphs 44 to 47 of TR 97/23 discuss improvements. 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. Some factors that point to work done to property being an improvement include whether the work will extend the property's income producing ability, significantly enhance its saleability or market value or extend the property's expected life. Paragraph 46 states: If the work entails the replacement or restoration of some defective, damaged or deteriorated part of the property, one does not focus on the effect the work has on the efficiency of function of the part. That is not determinative of whether the property is repaired or improved. It is a relevant factor to consider, however, in considering the effect of the work on the property's efficiency of function. It is possible, for instance, that the replacement of a subsidiary part of property with a part better in some ways than the original is a repair to the property without the work being an improvement to the property.
• Repairing property means fixing something that is broken or damaged. It does not necessarily make the property better than it was before, but it does make it function the way it is supposed to. • Improving property means making it better than it was before. This could mean adding new features, making it more efficient, or making it more valuable. Use of different materials An improvement is anything that makes part of the property better, more valuable, more desirable or changes the character of the item that is being worked on. Paragraphs 88 and 89 of TR 97/23 provides the following: The High Court of Australia (Windeyer J) said in W Thomas & Co Pty Ltd v. FC of T (1965) 115 CLR 58 at 72; (1965) 14 ATD 78 at 87 :
'The words "repair" and "improvement" may for some purposes connote contrasting concepts; but obviously repairing a thing improves the condition it was in immediately before repair. It may sometimes be convenient for some purposes to contrast a "repair" with a "replacement" or a "renewal". But repairs to a whole are often made by the replacement of worn-out parts by new parts. Repair involves a restoration of a thing to a condition it formerly had without changing its character. But in the case of a thing considered from the point of view of its use as distinct from its appearance, it is restoration of efficiency of function rather than exact repetition of form or material that is significant. Whether or not work done upon a thing is aptly described as a repair of that thing is thus a question of fact and degree.' It is therefore more significant in applying the word 'repairs' in its context in section 25-10, to consider whether the work restores the efficiency of function of the property for income purposes (without changing its character) than it is to consider whether the appearance, form, state or condition of the property is exactly restored.
In your case you replaced deteriorated timber retaining walls within your property with steel and concrete ones. Replacing a damaged item with a significantly upgraded version will generally be classified as an improvement rather than a repair and is therefore not immediately deductable. As the material used on the retaining wall is consistent with significantly upgraded materials, all the cost of works relating to the retaining walls are improvements and as such are not deductible under section 25-10 of the ITAA 1997. However, a deduction is allowable under Division 43 of the ITAA 1997 for capital works. You can claim a capital works deduction for the cost of construction for 40 years from the date the construction was completed at a rate of 2.5%. You will need to calculate this based on the percentage of the property that was used for producing assessable income and the 48 weeks you leased the room out.