Repairs and Improvements: Recognising the difference

The Australian Taxation Office (ATO) differentiates between repairs and improvements. To ensure the best results are obtained from an investment property, it is important to understand the difference between the two claim options.

Definitions
Deductible Repair: Returning items or property to their original state; an exercise in retaining the value of the item or property. Repairs attract an immediate 100% deduction in the year of expense.

Improvement: Improving the condition of an item or property beyond that of when it was purchased. Improvements are capital in nature and as such, must be depreciated over time.

Three tests
When determining whether a repair or improvement has been made, often three basic tests are employed. They are:

1. Has the condition of the property been improved beyond the original condition at the time of purchase? When an item was partially or fully replaced, it needs to be determined whether it was done due to the item being damaged, or done to improve what was previously there.



2. Has the property been established as an income producing property? The ATO states that repairs must relate directly to the wear and tear or other damage that occurred as a result of renting out the property.



3. Was the asset partially replaced, or replaced in its entirety? Partially replacing an item, like a fence panel, due to damage or wear and tear, often implies that a repair is being carried out. However, if a fence panel needs to be replaced, but the property owner decides to replace the entire fence (for no apparent reason except to improve the property’s value), this will be classified as an improvement.

Important Points

• When completing repairs, they should be carried out when the property is tenanted. The ATO will allow repairs as a deduction only if the property is being used for income producing purposes at that time. However, if tenants have recently moved out and repairs need to be made due to damage caused by those tenants, the repairs will also be allowed as a deduction as the damage occurred when the property was income producing. It is also important to consult your accountant when making a repair claim, as it becomes a 100% immediate deduction.
• It is important to note that an initial improvement at the time of purchase will not give rise to an immediate tax deduction. Property investors may be able to claim the cost of an initial improvement under the special construction write-off provision, or create a plant or article which may be depreciated over time, but it will not create an immediate deduction in its own right.

Examples

When to Consult a Quantity Surveyor
Before Making Improvements
It is important to consult a quantity surveyor before conducting any improvements as the old structure may be able to be ‘scrapped’. Essentially if an item is scrapped, the written down value of the item can be written off as a 100% tax deduction at the time of disposal. It is a very complex procedure to prepare such reports, the process involved in determining the amount of potential deductions available from a property requires the engagement of a specialist quantity surveyor.

After Making Improvements
A specialist quantity surveyor is able to maximise the depreciation deductions from an investment property when works are deemed to be capital improvements. Under TR 97/25, quantity surveyors are appropriately qualified to estimate construction costs for depreciation purposes.

When the total construction cost of an improvement is known, BMT & ASSOC utilise methods that are ATO accepted to maximise depreciation deductions through the apportionment items such as preliminaries, consultant fees and other associated costs.