A taxpayer was recently denied an immediate tax deduction for a roof repair and replacement for a rental property required due to vermin damage. The reason the deduction was denied by the ATO was because the repairs were considered to be “initial repairs” and capital in nature under section 25-10 of the Income Tax Assessment Act 1997.
What is an initial repair?
Repair work done to a rental property where the defects or damage are already in existence at the date of acquisition are considered by the ATO to be initial repairs.
In the case of this taxpayer, when purchasing the property he had building and pest inspection reports completed. The reports identified vermin damage. The work required to be done included removal and replacement of the roof as well as studs, top plates and roof trusses.
The above damage to the property was already in existence when the taxpayer signed the contract for purchase of the property. The repair work done to the roof after the purchase of the property was therefore considered to be an initial repair.
Initial repairs are of a capital nature and not deductible
Since the initial repairs were done at a time before the property was rented out for income producing purposes, the connection between the cost and the assessable income (rent) could not be established. This means that the cost of the initial repairs are of capital nature and no tax deduction was allowed. However, a deduction for depreciation or capital works in relation to the capital expenditure may be allowed.
Tax treatment: Repairs versus Improvement
Repairs = Immediate tax deduction
Improvements = Depreciable over time
Repair – when you repair an item you bring it back to its original condition (or working order). It restores the original function of the item without changing its character. The repair should not produce a new, better or different function or additional functionality.
- Replacing a rotten piece of timber on your pergola is a repair.
- Replacing a damaged section of a fence is a repair.
Improvement – when you improve an item beyond its original condition, it is considered an improvement.
- Knocking down the pergola and replacing the entire structure is an improvement.
- Replacing a damaged section of a wire fence with a powder-coated steel section is an improvement. Note: for small business taxpayers fencing improvements may now be fully deductible.
If you require any assistance with these matters in relation to your own investment property, please feel free to contact us for more information.