Last year more than one million property investors claimed over $25 billion worth of rental deductions.
BY TYRON HYDE
Quite staggering isn’t it. No wonder the Australian Taxation Office (ATO) has placed property investors on notice this year!
And there’s a good reason why the ATO focuses on this topic.
In my opinion it’s quite a grey area – and according to the investors we speak to, filled with confusion.
Tax ruling 97/23 is the bible when it comes to defining what constitutes a repair and what doesn’t. But it’s quite long and complex, so I’ll summarise what questions you need to ask yourself before you claim the work as an outright deduction, or whether you need to depreciate the work over time.
There are four basic tests that need to be satisfied before you can claim work as an outright deduction:
- Generally the work you do needs to relate to the wear and tear of the property while it was an income-producing asset for you.
- Repairs carried out when you initially buy a property are defined as ‘initial repairs’ and can’t be claimed as an outright deduction.
- If you replace the whole item, it’s not a repair.
- If you improve the material when carrying out the work it’s considered a capital improvement, not a repair, and is to be depreciated.
Consider these examples:
1. Jack and Jill buy a rundown 1930s weatherboard property that needs some work carried out to bring the property up to a rentable state. Five cracked roof tiles have caused leakage that’s damaged the carpet in one of the bedrooms. They immediately replace the carpet and replace the cracked tiles. They also get the plumber out to fix the faulty hot water heater.
This work clearly sounds like repairs in nature – but unfortunately it’s not, because the ‘damage’ was done prior to you acquiring the property. The ATO has defined this as ‘initial repairs’ and these costs are considered to be capital expenses and depreciated over time.
2. Jack and Jill buy a rundown 1930s weatherboard property that’s already housing a tenant. The tenant remains in the property for nine months, then moves out. With the tenant gone, the owners discover five cracked roof tiles that caused the roof to leak and damage the carpet in the bedroom. They immediately replace the carpet and cracked tiles. They also get the plumber out to fix the faulty hot water heater.
Guess what? This is the same work, but in this case Jack and Jill can claim the work as an outright deduction – because they believe the damage was caused after they had bought the property.
3. Jack and Jill buy a rundown 1930s weatherboard property with a tenant. The tenant moves out after nine months. With the tenant gone, the owners discover five cracked roof tiles that caused the roof to leak which led to carpet damage in the bedroom. They immediately replace all the carpet & the whole roof. They also get the plumber to replace the faulty hot water heater. In this case because Jack and Jill decide to replace the whole roof it will need to be depreciated at 2.5 per cent per annum over 40 years and not claimed as an outright deduction. The Plant & Equipment items (Carpet, Hot Water System) will need to be depreciated according to their effective life. Even though the roof was leaking, the hot water heater needed to be fixed and the carpet was water damaged!
In this example, if Jack and Jill had only repaired the hot water heater a mixture of outright deductions and depreciable items would be allowed, as long as they’re clearly separated.
4. Jack and Jill own a 1930s weatherboard property for several years before deciding to fix the dilapidated fence. The old fence was made out of timber palings. Because they’re cash strapped, Jack and Jill decide to fix the front fence only, leaving the rear and sides alone. They decided a nice new brick fence would be more suitable and will add value to the property.
In this example, although Jack and Jill owned the property for a while and only fixed part of the problem, they can still only claim this work over 40 years as opposed to an outright deduction. This is because the material they used was an improvement to the existing product or an upgrade.
So, if you’re claiming repairs to your property, make sure they’re legitimate and not capital improvements.
Have you been caught out in relation to repairs and capital improvements before? Tell us about your experience.
Tyron Hyde is one of Australia’s leading experts in property tax depreciation and Director of national Quantity Surveying firm Washington Brown. He has a degree in Construction Economics and is an Associate of The Australian Institute of Quantity Surveyors.