Tax Benefits for Repairs and Improvements on Investment Properties

Buying Investment Properties

Part of the risk of buying any property is its condition. There wouldn’t be too many contracts that don’t have “subject to building inspection” as a condition of purchase. The property’s defects are the primary bargaining chip to get the vendor to lower the price.

The extent of the repairs required could impact your ability to make the property immediately available for rent. Some repairs might need to be carried out before you put tenants in it, others may be able to be done at a later date.  None the less, these repairs will need to be done at some point. As is the case with any property, there will be other repairs that pop up along the way.

Repairs vs Maintenance

Most investment property owners rely on tax benefits to fund their investment. As a result, it is important they understand the tax treatment of the different types of repairs as these may have unanticipated impacts on cash flow.

Repairs

Repairs are often bundled in with maintenance however they are deductible under different sections of the act. A repair is usually partial and restores something to its original state (eg replacing a few broken fence palings). It is a specific deduction and is deductible under s25-10 ITAA 1997.

Maintenance

Maintenance on the other hand generally relates to work that prevents deterioration like the oiling of a deck or servicing swimming pool filters and pumps. Maintenance work is generally not deductible under s25-10 however it is deductible under s8-1.

Capital Expenditure and Improvements

As repairs and maintenance are both deductible (under different sections) there will be no difference to the tax benefit provided. It is, therefore, important to consider whether the expenditure is capital. If the investor is relying on tax benefits gained from the expenditure it is important to understand what expenditure will result in the best outcome.

Capital expenditure can be in the form of improvements, replacements or initial repairs and may or may not be immediately deductible.

Sometimes, work done to property may start as a repair and end up being an improvement. This is due to the change in efficiency or character of the property. Generally, this occurs where the materials used to make the repair differ to the original materials or where there are technological advancements. An example of a repair that results in an improvement would be the replacement of a dilapidated wooden fence with a colour bond fence. An example of a general improvement would be building a garage or carport.

A replacement will be treated as capital and not deductible where an asset in itself has been replaced. This is distinguished from the replacement of part of an asset which would be a deductible repair. An example of a replacement treated as capital would be the replacement of an air conditioner. A replacement treated as a repair would be the replacement of the compressor which is part of the air conditioner.

Initial repairs on a property

Initial repairs are not deductible and form part of the cost of the asset. These repairs are quite often considered to be those that are carried out prior to the property being available for rent, however, the timing of the repair does not alter the repair being an “initial repair.” This means that repairs undertaken at a later point may still be treated as initial repairs if the defects existed at the time of acquisition.

These repairs are treated as capital because it is considered that the purchaser would have received a reduction in the purchase price of the property to take into account the cost of the repairs.

Although capital items are not deductible in the year they are incurred, they may be depreciated over the effective life of the asset or as capital works. The effective life is different for each asset and some assets will depreciate faster than others. Capital works, however, depreciate over 40 years at a rate of 2.5% per annum.

Assume $4,000 was incurred on 1 July 2015 on a property and the taxpayer has a marginal tax rate of 32.5%. The different types of “repairs” will result in the following tax savings in the year ended 30 June 2016:

Type of Work Deductible/Depreciable Tax Saving
Replace part of a roof Deductible $1,300
Replace an oven Depreciable over 12 years $333
Replace gravel driveway with concrete driveway Depreciable over 40 years $100
Initial repairs (defects present at acquisition) Form part of the cost base of the property $Nil

 

This information in general in nature and should be used as a guide only. If your investment property requires repairs and you are unsure of how they will be treated for tax purposes you should speak with your accountant.

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