Deductions and rental properties: Repairs vs improvements
What constitutes a repair? What constitutes an improvement? And when does a repair become an improvement?
It is clear that the area of deductions in respect of repairs to investment properties continues to be problematic.
In this context, it is critical to distinguish between:
- Ongoing repairs, which are deductible;
- Initial repairs, which are not deductible; and
- Improvements, which are not deductible.
If the amount in question falls into the category of initial repairs or improvements, the amount in question is not deductible. However, it would be considered as expenditure that may qualify for depreciation purposes, capital works purposes, or as part of the cost base for CGT purposes.
An amount of expenditure would constitute initial repairs if the asset was in disrepair at the time of its acquisition, and before letting out the property, the owner carried out the repairs.
What is a repair?
The more problematic issue is the distinction between repairs and improvements.
Repairs generally involve a replacement or renewal only of a worn out or broken part, or relate directly to wear and tear or other damage that occurred as a direct result of renting out the property.
Common repairs would include things like replacing broken windows, repairing electrical appliances or machinery, and replacing worn guttering and fences. It might also extend to work done to prevent deterioration, such as painting a rental property, or cleaning something which is otherwise in good working order.
What is an improvement?
By contrast, improvements go further. They fundamentally change the property that previously existed in some meaningful way rather than maintaining and merely repairing the property.
Extensive landscaping or adding a deck to a property would ordinarily constitute an improvement. To put it another way, if what has occurred is more than merely restoring what previously existed to its original condition, it is likely to be treated as an improvement and therefore not deductible.
In trying to evaluate whether an amount of expenditure is an improvement, consider the following two questions:
- Does the expenditure give rise to a material increase in the efficiency in the functioning of the property?
- Does the expenditure give rise to a material increase in the value of the asset?
If the answer to either of these is yes, it is likely that there is a capital improvement which is not deductible.
Some important cases where there is an improvement rather than a repair include:
- The replacement of a dilapidated ceiling with an entirely new and better ceiling;
- The replacement of a rotten wooden floor with a better, longer lasting, and more moisture resistant concrete floor; and
- The replacement of cupboards as part of the refurbishment of an entire kitchen.
Clearly, this is an area that causes much confusion and compliance can be problematic. Taxpayers need to be careful to ask the right questions and ensure their answers are properly considered with a reasonable degree of objectivity.
Tip! Your tax adviser can assist you in determining what expenses are in fact deductible.
Ref: TaxWise Individual September 2019