ATO focusing on repairs vs. improvements

The Australian Taxation Office is paying particular attention to claims that investment property owners make for repairs to rental properties. All clients should note repairs are deductible, improvements are not. Though improvements may add to the cost base.

There are many examples of case law to assist in differentiating between repairs and improvements and the ATO has offered its interpretation of the difference.

• Whether or not the thing replaced or renewed was a major and important part of the structure of the property

• Whether the work performed did more than meet the need for restoration of efficiency of function, bearing in mind that “repair” involves a restoration of a thing to a condition it formerly had without changing its character

• Whether the thing was replaced with a new and better one, and

• Whether the new thing has considerable advantages over the old one, including the advantage that it reduces the likelihood of repair bills in the future.

EXAMPLE TO ASSIST WITH CLASSIFICATION

Mary Fabrica owns a factory in which the bitumen floor laid on a gravel base needs repairing. She replaces it with a new floor consisting of an underlay of concrete topped with granolith (a paving stone of crushed granite and cement).

The new floor, from a functional efficiency (rather than an appearance) point of view, is not superior in quality to the old floor. The new floor performs precisely the same function as the old and is no more satisfactory. In fact, the new floor is more expensive to repair than the old.

Because the new floor is not a substantial improvement, it is a repair and its cost is most likely deductible.

Of particular interest to the ATO is the issue with initial repairs, i.e. expenditure made soon after purchase which actually are reflected in a discounted sale price, and are therefore capital, and not tax deductible.

A taxpayer recently claimed repairs and maintenance for a newly acquired rental property, which was significantly improved upon purchase. The taxpayer provided an invoice from an interior developer for the refurbishment; of the property.

Further documentation detailed the scope of the refurbishment, which included completely stripping the property and replacing old fixtures and fittings with new. The large repairs and maintenance claim was disallowed because initial repairs and improvements to a property are not deductible.

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