As housing prices soar, more and more people are purchasing rental properties as investments to secure their future.
Most taxpayers understand that the construction costs incurred while building a new rental property are capitalised, and therefore claimed over a number of years.
What isn’t understood is the topic of what can and cannot be claimed as repairs and maintenance vs capital improvements when maintaining or renovating your existing rental property.
In an attempt to attract higher rental incomes, or to improve the value of their investment, people are spending significant amounts of money on renovations. The ATO have expressed concerns about the confusion surrounding the way that these expenses are treated by taxpayers when tax time comes around.
What’s Causing the Confusion?
The chief reason for the muddying of the waters around this issue is that there are a lot of different types of expenses involved in a renovation. Some components are capital, some may be repairs while others may represents depreciable fixtures and fittings. There are also specific circumstance surrounding each property with regards to construction date, current owners purchase date, purpose for which the property has been used in the preceding years, climate conditions, and so on. These all make it difficult to make generalisations about the possibility of deductions.
Another principal cause of confusion is the need to draw a diction between ‘repairs’ and ‘improvements.’
What’s the Difference Between a ‘Repair’ and an ‘Improvement’?
The distinction between these two poles is grey, but that doesn’t give taxpayers an excuse for incorrectly claiming expenses.
Essentially, a ‘repair’ is an action undertaken to address defects, damage or deterioration to the rental property. In other words, a ‘repair’ is something that is designed to allow the property to continue to exist in its current state. Repairs of this nature are tax deductible.
If you carry out work on your rental property that involves substantial reconstruction or replacement of aspects of the property, then this is deemed an ‘improvement.’ The expenses involved in making this improvement are capital in nature and not deductible.
To illustrate the difference, take the example of a damaged façade at a rental property. If the owner decides to repair the façade and largely keep it in its original state, it is considered a repair and the owner can claim the expense as a tax deduction.
If the owner decides to completely replace the façade, by rendering it or replacing the material, the owner will have engaged in a process of improvement. The expenses incurred will be considered capital in nature subject to a different deductibility entitlement entitlement process.
Not All Maintenance Costs Are ‘Repairs!’
Another consideration is evaluating the necessity and the end-result of the repair or maintenance. When conducting maintenance on your rental property, you need to be aware that you can only claim deductions for maintenance that are needed vs purely discretionary. For example, if you recoat your roof tiles to prevent further deterioration of the property this can be claimed as a ‘repair.’ If you replace the roof with a different material eg metal roof for an aesthetic reason, the expense would be viewed as a capital improvement.
Capital Works Expenses
Capital improvements designed to improve the asset are added to the cost base of the property and with an allowable deduction of 2.5% per annum over a 40 year period.
Initial repairs carried out on rental properties are also considered capital works, as they are designed to fix defects or damage to the house that was present at the time the property was acquired. These represent repairs that are undertaken to remedy defects, damage or deterioration of the property that existed at the time the taxpayer purchased the property.
Whether the taxpayer was aware of these damages, defects or deterioration has no bearing on their ability to claim deductions. It is up to the buyer to be aware of any pre-existing damage requiring repairs in the upcoming year.
Any travel or accommodation costs incurred during these initial repairs are also capital in nature, meaning no deduction is available.
The table below provides a guideline of what may and may not be claimed as a tax deduction.