Large rental property repairs were not deductible.

In a recent PBR, the Commissioner indicated that the removal and replacement of a defective roof (vermin damage) on a property rented for several years was not a tax deduction.
The relevant facts are:

• The property was purchased a number of years ago. Necessary building and pest inspections were carried out at that time.
• Both reports advised that vermin damage was identified to the property.
• The building report advised “structural timber pest damage was present in the roof”.
• The investor has carried out ongoing pest control services to treat the house.
• The treatments were unsuccessful. So the investor eventually agreed to remove and replace the roof.

As the vermin damage existed at the time of purchase the replacement of the roof was not deductible. However building depreciation may still apply as a capital works for the property.
Secondly, the expenses incurred by the taxpayer in the years since the purchase for ongoing pest control maintenance may also be considered an initial repair. So the initial tax claims for pest control maintenance will also be not deductible (but could potentially be claimed over an effective life calculation).

Whether the taxpayer was aware of the damage on acquisition was irrelevant. So the simple act of finding long term termite damage after you have held the property for several years requires an understanding of when the damage arose to determine deductibility.

This ruling puts a focus on all large scale repairs undertaken by landlords. In particular any large scale repairs on properties that are less than 5 years old should warrant a significant level of review.

PBR 1013123727436

 

must have been some mean Vermin to cause a root replacement!

ATO's position seems to be logical.

 

This is the key point I think.

 

I still hear many people quote the "12 month rule". The concept that repairs in the first 12 months are initial repairs and repairs after that date are ordinary repairs. In this case, even though the property was rented for many years, were still held as initial repairs.

And whether the taxpayer knew about the damage or not when they purchased the property was irrelevant.

 

It would apply to capital works and deductible that way.

 

I was always under the belief that an entire replacement, whole roof, fence, kitchen etc, was an improvement and not a repair. No matter when carried out.
Marg

 

agreed a logical position and confirms the view that the ATO considers repairs done to something when it is a known defect at the time of acquisition to be a capital expense. not even sure why they bothered with a private ruling

 

I had a curly one for a client recently. This may demonstrate that what seems clear often is NOT and seeking advice can even benefit a taxpayer.

Purchased property and it had minor corrosion evident as surface corrosion only on the P&B. Soon after major QLD storm damage in 2011 and the insurer remedied some roof defects causing leaks cased by storm damage etc. The roof was substantially unaffected and was retained at that time. The property is close to sea spray I will note. 2016 the whole steel roof required replacement at significant cost due to extensive leaks which had developed.

Firstly I was told by client that roof defects was evident but was not told the severity (not severe IMO). Client suspected it was a non-deductible repair. I suggested we needed to review it. I needed to firstly exclude initial repairs. Based on two factors I was satisfied initial repairs were not made:
a. No major defects evident at the 2011 storm damage six months after acquisition. The insurer and assessor would have considered the roof to be of a worthy standard six month after acquisition.
b. Original P&B report - Original surface corrosion was not a major defect that concerned the inspector (noted in report as surface corrosion) or cause for any leakage concerns.

So I was satisfied that an initial repair did not occur. The question is then if the cost is either capital or deductible as a repair.

The WHOLE roof was replaced to effect a repair of leakage in numerous places and defects in the water barrier provided by the steel roof. Based on the earlier opinion the roof was damaged by salt corrosion in the period between 2012 and 2016. A similar but different material was used to resurface the roof - colourbond steel to address corrosion in the future. This doesnt affect deductibility as it is just a functional change. A tiled roof for example may pose a concern to a deduction. Based on these views a repair seems evident BUT the question is - Could it be capital expense through replacement of the whole roof ?

IMO this was a deductible repair. The roof is merely a part of the building and the whole building was not replaced hence a building repair can occur and a roof replacement is a partial repair of a defect to the building and this is consistent with the ATO Ruling. ie Roof is a part of the whole building.

It was essential to review documentation and also discuss the period of ownership and all relevant facts to arrive at this view.

Without discussion and advice this deduction would have either been recklessly claimed OR not made

 

No contention in the pbr.

Courts have long held that costs to remedy a defect existing at the time of acquisition are capital costs associated with the acquisition.

Merely delaying the repairs and using the asset in the interim just makes the capital nature harder to identify.

 

Colourbond within 5km of the ocean reduces its warranty.

 

The issue in my client concern had to address that precise problem. I had to exclude initial repairs firstly. The ATO view is that even a defect the taxpayer was unaware of, is a initial repair. Its bizarre that there is no time period whatsoever but surely one must always apply to every defect if an asset existed at acquisition. Otherwise an asset evident at acquisition would always be an initial repair unless an event occurs to damage it eg a storm, tenant etc.

So when does common sense replace the initial repair rule ? Its a fundamental flaw in the ATO repair ruling IMO.:

1. Taxpayer buys an IP and finds a sewer blockage cased by roots three days later. Argueable its an initial repair.
2. Taxpayer owns the IP for ten years and then finds extensive tree roots blocking sewer. Is arguable the root damage occurred in the ten years..

But what about when its uncertain?

Problem is when does a cost shirt from capital to deductible based on time ?

 

Stainless steel roofing isnt in anyones budget !! (does it exist ?) In cyclone prone northern areas there isnt a real choice but to use colourbond.

 

@Paul@PFI - there's always copper which is a shade cheaper.

 

I would argue before its fully laid someone would be stealing it. People rip up Telstra copper lines.

 

The tree may have been small or not existed in 10 years, but with technology these days you better be sure.

A blockage would also be because of human usage at the time, the ones responsible for income generation, without them the roots would not be in the sewer.....

Would be an interesting argument, but this must have been encountered already ?

 

Always a question of fact.

e.g. old clay pipes are prone to cracking and invasion by certain tree roots.

Costs to line the pipe or replace with PVC could be regarded as an improvement in function ... i.e. add tree root resistance.

 

It would make sense that running an eel to clear a choke is R&M but changing to plastic is an improvement.