Investment Property - Are you entitled to a Deduction on Initial Repairs
You are not entitled to an income tax deduction for the cost of initial repairs that relate to the remedying of defects, damage or deterioration to a property that existed at the time of purchase and did not arise from the operations of the property owner who incurs the repair expenditure.
The cost of effecting initial repairs is still not allowable even if some income has been earned before the repair expenditure is incurred. In other words, the character of initial repairs is not altered because income is derived from the property before the expenses are incurred on the initial repairs. This would apply equally where the property is being 'held' for rental purposes but no rent has yet been derived.
If an initial repair expenditure is not deductible it may be able to be included in the cost base of the rental property - see ‘Capital Gains Tax’ section below.
Example 1 - You purchased a residential property that was in a state of disrepair. After listing the property, you incurred costs in carrying out repairs to remedy the defects which existed at the time of purchase. This in turn made sure that rents received on the property were maximised.
In the above example, you will not be entitled to a deduction for income tax purposes as the property was in a state of disrepair at the time of acquisition and none of the defects arose in the course of renting out the property. The repairs carried out are initial repairs.
This is even the case where a rental property is inherited through a will and was previously used as a rental property before it was inherited by you.
Example 2 - You purchase a property and use it as your main residence for some time. After a few years, you decide to move to a larger home as the family has outgrown the original home. You decide to keep the existing house and rent it out. A short time after renting it out, you incur costs in carrying out repairs to the property to remedy the defects that arose during the time it was your private residence including plumbing repairs for leaking taps, and repainting the house.
Taxation Ruling TR 97/23 provides that in 'appropriate circumstances' the cost of repairs may be deductible even though the taxpayer previously held or used the property for non-income producing (ie private) purposes.
These appropriate circumstances include where a rental property owner incurs expenditure to remedy defects, damage or deterioration to their rental property that are attributable in whole or in part to the previous private use of the property by the owner, and the repairs are not capital in nature.
Capital Gains Tax (CGT)
We have outlined above the circumstances in which an initial repair is not immediately deductible. Where it is not deductible, the initial repair expenditure may be able to be included in the cost base of the rental property. The cost for CGT purposes consists of five elements:
- acquisition costs (ie purchase price of house);
- incidental costs (eg legals and stamp duty);
- if the property was acquired after 20 August 1991, non-capital costs of ownership which are not deductible (eg interest payments on the loan to purchase the property where the property is not rented);
- capital expenditure to increase the value of the asset (refer below); and
- capital expenditure to establish, preserve or defend title to the asset or a right over the asset.
Initial repairs are considered under point 4 of the cost base as capital expenditure to increase the value of the asset. However, initial repairs can only meet point 4 of the cost base definition if the initial repair is reflected in the state or nature of the asset at the time of the sale of the rental property.
Please contact this office if you have any questions concerning deductions on your rental property.
