Taxation Ruling TR 97/23, released in December 1997, outlines the tax deductibility of expenses incurred on repairs to premises, plant, machinery, tools and articles.
Investment property repairs, maintenance and capital improvements are distinct from each other in the eyes of the Australian Taxation Office, as outlined in TR 97/23. Costs to repair or maintain an investment property can typically be claimed as an immediate tax deduction in the year that the expense was incurred, while capital improvements are not immediately deductible and must be classified as either a capital works deduction or as plant and equipment depreciation.
Given that these things are not always clear cut, judgment often needs to be exercised when determining whether something falls under repair, maintenance or capital improvement. This can be difficult, so we provide some simple guidance here.
Under section 25-10 of the Income Tax Assessment Act 1997 (ITAA 97), repair means ‘the remedying or making good of defects in, damage to, or deterioration of, property to be repaired (being defects, damage or deterioration in a mechanical and physical sense).’
For the most part, repair is simply to replace or correct something that has become worn out or dilapidated. It involves restoring to former appearance, form, state or condition without changing character.
Works can fairly be described as ‘repairs’ if they are performed to fix:
- deterioration that has occurred by ordinary wear and tear, or
- accidental or deliberate damage, or
- the operation of natural causes (whether expected or unexpected) over time.
For example, fixing a crack in plaster would be considered a repair.
When determining whether work constitutes repairs, it is important to consider whether the work restores the efficiency of function of the property without changing its character. A minor degree of improvement, addition or alteration can be a repair, however, if substantial, it is not a repair and not deductible under section 25-10 of ITAA 97.
According to TR 97/23 ‘renewal, replacement or reconstruction of the entirety (i.e., the whole or substantially the whole) of a thing or structure is an improvement rather than a deductible repair’.
According to TR 97/23, if work is in anticipation of, or to prevent, damage or deterioration, it is considered maintenance. Some examples include routine preventative work such as repainting faded walls, maintaining plumbing and deck oiling.
Repairs and maintenance often go together, in that repairs will frequently include maintenance work. And some kinds of maintenance work are ‘repairs’ in terms of section 25-10, for example, painting premises to rectify existing deterioration and to prevent further deterioration
There is also a difference between a ‘repair’ and an ‘initial repair’. While a repair is performed to restore an item, an initial repair is to fix damage which was pre-existing when the property was purchased (whether known to the buyer or otherwise).
Initial repairs are of a capital nature, so are not deductible under section 25-10 of ITAA 97.
Any works that improve a property beyond its original state are classed as capital improvements. According to TR 97/23, an ‘improvement ‘provides a greater efficiency of function in the property – usually in some existing function.
Some indicators that the work performed is 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.
A capital improvement will be classified as either a capital works deduction or as plant and equipment depreciation.
- Capital works deductions
Capital works refer to the deductions available for the building’s structure and permanently fixed items. If the property owner is replacing an entire structure that is only partially damaged or is renovating or adding a new structure to the property, it is likely to be capital works. The rate of deduction for capital works is typically 2.5% per year for 40 years from the date of construction. An increased rate of 4% can be used for some property types.
- Plant and equipment depreciation
Plant and equipment assets are items which are mechanical in nature or can be easily removed from the property. If the property owner is installing a brand-new asset such as an appliance, curtains or floor covering, then it is likely to be a depreciating asset. Each asset’s condition, quality and effective life determine the allowances available. Plant and equipment assets can be depreciated using either the diminishing value or prime cost method.
Let’s consider the example of a rental property that is undergoing a kitchen renovation.
Retiling splashbacks and installing a new marble benchtop would be deemed as capital improvements and be claimed as capital works deductions at a rate of 2.5 per cent over 40 years.
A new rangehood would be claimed as a plant and equipment asset and be deducted based on the asset’s effective life. If the rangehood was purchased and installed for less than $300 it would be 100 per cent tax deductible in the year the expense was incurred.
And if a crack in a cabinet was fixed, it would be considered a repair as a damaged asset is being restored. The expenses involved would then be claimed as an immediate deduction.
Answers to common questions
- How can I tell if the work constitutes a repair, maintenance or capital improvement?
It can get complicated when work falls under more than one category. For example, repair work doesn’t stop being a ‘repair’ if it is also maintenance i.e. the work is performed to prevent – or in anticipation of – defects, damage or deterioration. Repairs can also take place at the same time as capital improvements.
The best rule of thumb when determining something is a repair, is to consider whether the work restores the efficiency or function of the property without changing its character. As mentioned previously, a minor degree of improvement can still be a repair, but if the change is substantial it is not a repair and therefore not deductible under section 25-10 of the ITAA 97.
If ever in doubt, get in touch with BMT and we will be able to help.
- Is painting a repair, maintenance or capital improvement?
A rental property is typically painted to help keep it in its original, functional condition. Because this is routine and preventative, it would generally be considered maintenance. But in some cases, it could also be considered an improvement if it is not in need of repair or maintaining and the painting is more to do with improving the appearance and marketability.
- Is the repair expenditure of a capital nature?
Repair expenditure is capital in nature if it restores the original former appearance, form, state or condition of an item – but the item’s character is changed.
An example is a ballet studio that had its roof damaged by storms. The roof was in good working order prior to the storms, but the owner of the studio chooses to replace the roof using superior materials that better withstand wind, fire and rain. Since the roof has been improved, this repair expenditure would be of a capital nature and not deductible under section 25-10 of the ITAA 97.
If experiencing practical difficulty in deciding whether particular repair expenditure is deductible under TR 97/23, BMT can help. We will also make sure that the original tax depreciation schedule is updated accordingly. Contact us on 1300 728 726.