Are repairs to investment property tax deductible?
Last year more than a million property investors claimed Billions and Billions of dollars in rental rental deductions.
Quite staggering isn’t it. No wonder the Australian Taxation Office (ATO) seems to target property investors every year!
For as long as I can remember, around June, the ATO releases a statement warning property investors to be careful about what they claim.
And every year they warn that if you are claiming repairs to your property make sure they are legitimate and not the capital works allowance.
There is 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.
Part of the reason is that the word “repair” is not actually defined within the tax legislation.
Therefore, it takes its ordinary meaning – which is “the restoration of a thing to a condition it formerly had without changing its character”. (W Thomas & Co v.FC of T (1965) 115 CLR 58).
It is confusing whether repairs to investment property are tax deductible and sometimes it’s best to simply contact us and speak to an expert.
Tax ruling TR 97 /23 is the bible when it comes to defining what constitutes a repair and what doesn’t.
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 not. If not you will need to organise a Tax Depreciation Schedule.
There are four basic tests that need to be satisfied before you can claim work as an outright deduction:
- The work you do needs to relate to the wear and tear of the property whilst it was an income-producing asset for you.
- Repairs carried out when you initially buy a property are defined as “initial repairs” and cannot be claimed as an outright deduction.
- If you replace the whole item – it is not a repair.
- If you improve the material when carrying out the work – it is considered a capital improvement, not a repair, and is to be depreciated.
It may be best to get a tax depreciation schedule quote for your property and we can with you to discuss the best way moving forward.
The best way to highlight whether repairs to investment property are tax deductible is through a series of examples:
Repairs tax deductible or not example 1
Jack and Jill buy a run down 1930’s weatherboard property that needs some work carried out in order to bring the property 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 & 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 is 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.
Repairs tax deductible or not example 2
Jack and Jill buy a run down 1930’s weatherboard property that’s already housing a tenant. The tenant remains in the property for 9 months then moves out. With the tenant gone, the owners discover 5 cracked roof tiles that caused the roof to leak and damage the carpet in the bedroom. They immediately replace the carpet & cracked tiles. They also get the plumber out to fix the faulty hot water heater.
Guess what? This is the same work… and in this case, Jack and Jill can claim the work as an outright deduction. That’s because they believe the damage was caused after they had bought the property.
Repairs tax deductible or not example 3
Jack and Jill buy a run down 1930’s weatherboard property with a tenant. The tenant moves out after 9 months. With the tenant gone, the owners discover 5 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 item. The work they carried out will need to be depreciated at 2.5% per annum over 40 years and not claimed as an outright deduction. 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 is allowed. As long as they are clearly separated.
Repairs tax deductible or not example 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. 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 & only fixed part of the problem, they can still only claim this work over 40 years. They can’t claim the work out-right because the material they used is an improvement to the existing product or an upgrade.
In summary, this is quite a complex area and there are many other scenarios I could run through to confuse you!!
It’s an area that’s always targeted by the ATO – because, even though logically the work you are doing would seem to be a repair, unfortunately, in the eyes of the ATO it might be of a capital nature.
So, if you think you can buy an old property, renovate it straight away and get a massive deduction in one hit, think again.
At the end of the day, all these repairs can be claimed against your taxable income… some just quicker than others.