Repairs and tax deductibility

Your tenant calls and says the hot water service at the IP has packed up. Tells you to fix it, fast. So, a maintenance person is sent out. Maintenance person looks at it and says ‘Ah mate, that’s completely ****ed, you need to replace it’. So, he pulls the old one out and puts in a new one (identical make and model). Labour and materials = $1,600.

Is the $1,600 immediately tax deductible?

 

yes as long as the unit is not an improvement

 

No, not deductible. The expense is capital expenditure. It exceeds $400 and must commence Depreciation and the Commissioners effective life tables define it as such. The formed item may be scrapped if it has residual value (except if it is now in a depreciation pool). This capital expenditure test applies whether replaced OR improved. The exception is if it is repaired.

If the repairer replaced part of the unit (eg water tank and element) then it would be deductible as a repair but HWS are replacement units and typically not repairable except minor matters eg igniter.

 

Thanks Paul. In relation to repairs, does it swing on how much of the item is damaged and hence repaired. So, if a tree falls on a fence and damages 30% of the fence, and you rebuild (repair) that percentage, this is arguably fully tax deductible. If the tree knocks over 100% of the fence, and you replace the fence completely (like for like, so no improvement), then that is capital expenditure and hence not deductible in first year?

 

It relates to the difference between replacement and repair. A repair restores function and remedies a defect. Replacement does not remedy a defect as the defect still exists in the scrapped item. A replacement means the unit is replaced and no rectification of function to the defective unit occurs. Its not a difficult concept. If you have a major car accident then a new car is not a repair. Its a different engine, body and VIN etc. But if its repaired it may just have a new front end etc. eg the new HWS has a different mfrg date, serial no etc.

Fences are never depreciable other than as a element of the building at 2.5%pa so thats a bad choice, But you can replace a section of fence. A repair.

Your question was about a HWS that was replaced.
Ah mate, that’s completely ****ed, you need to replace it’. So, he pulls the old one out and puts in a new one (identical make and model)

Even if a repair was economically a higher cost it is the ONLY way to access a deduction. Once the heater is replaced it a new capital item and depreciable.

 

Paul,

Thanks again. I looked at TR 97/23 that covers deductions for repairs, and gives summary of the case law. Issue seems to hang on whether you are reconstructing asset in its ‘entirety’ and what is meant by ‘entirety’. Covered in paragraph 37-42.

Paragraph 40 is particularly relevant. In the case of the water heater, it is arguably part of the building, similar to window in building (window is not useful in and of itself) hence part of the building, and therefore this is not being replaced ‘in its entirety’.

Are there other TRs or case law that go directly to this issue?

 

@Paul@PFI - if, for example, the "scrapped" HWS was only four years old, and you can't sell it for anything, could you immediately write off its remaining depreciation / residual value? Assuming of course you were claiming depreciation on it before it broke.

 

As long as you're continuing to use the property to generate income, then yes.

 

Paul,

Further to my earlier post, paragraph 117 and 118 of TR 97/23 also arguably supports the immediate deductibility of this expense. The High Court case of W Thomson and Co is particularly on point.

 

I think Paul is right (for once ). I repair is bringing something back up to the original condition. If you replace a whole hotwater tank that would not be a repair but a replacement.

see paras 13 to 16 of TR 97/23

 

Hi Terry, appreciate the response. Sorry to be a bit of a dog with the bone, but in paragraph 13, the word ‘replacement’, is used within the context of defining a repair (‘a repair merely replaces a part...). So, I don’t see the ruling making a particular distinction between ‘repair’ and ‘replacement’ per se. When I read TR 97/23, the question appears to turn on whether it is a replacement in ‘its entirety’ (not immediately deductible) or whether you are merely fixing (or replacing) a part of a greater asset (deductible). On the one hand, you could argue it is the former, in that I have replaced the entire water heater, so not deductible. But paragraph 117-118 touches on what is meant by ‘in its entirety’. Is the asset the entire building (water heater being a part) or is the asset the water heater. One factor the courts look to is whether the asset can produce income in itself. Much like replacing a light globe because it is busted (deductible), the water heater is a part of a building which is producing the assessable income. Arguably, the water heater is not a useful asset in itself (without the building). So, it is part of the greater building, and as you are not replacing the asset (income producing building) in its entirety, it is deductible. The cases quoted in paragraph 117-118 of the ruling are particularly interesting and go directly to this issue. Not as straightforward as I first thought.

 

Yes it could be argued each way. Best to try to find out what the common practice is of the ATO and then consider whether you should do it their way or potentially rock the boat.

 

A HWS is NOT part of a building. It is a listed asset in the Commissioners rulings and may be installed in or adjacent to a building but IS NOT a building element. Nothing to argue either way. It is NOT Div 43 and is a listed asset in the Commissioners effective life tables.

No issue to debate, argue or dispute. It must be depreciated. Like an AC unit, a lift, escalator, kitchen appliance etc.

 

Confirmed.

 

I find this issue with around 3-4 taxpayers a year. They get pinged and then call me hoping I can object and appeal the Commissioners decision. The usual basis is one of the following arguments:

1. Its part of the building when its installed
2. Its was a repair by replacing since the replacement was cheaper than a actual repair
3. I have two HWS so replacing one is not the entitrety
4. I had to pay for the unit upfront so it should be deductible upfront. It not on finance. etc

Everyone of them gets told we cant and wont assist as the Commissioners view is rigid and part of common law and tax law and our involvement would be a wasted cost. Same with ovens, range hoods (if they cost $300+ incl frieght and install) and any other enduring items

The other biggie is Body Corporate / Strata levies. Special levies are NOT deductible as they may be used by the Strata to raise cash to perform major works eg replace fascade, balcony etc. The cost falls under Div 43 and ONLY when the work is completed then a QWS report that incorporates the owners share of common property + share of their own property is eligible. This is NOT the amount of the levies paid! Consult a QS after the work is completed. The strata committee information about total costs paid for the works would also assist. I get around 3-4 taxpayers a year that seek to object that too.

 

I think it is also not the same or similar to a roof. A roof is part of the house, part of the construction. But a HWS is a separate asset.

 

@Paul@PFI

Thanks All. So, assume the original unit was bought for $1500, and was already depreciated by $1000 (WDV = $500). Found to be faulty, scrapped and replaced by another $1500 brand new unit.

Is the deduction in that year therefore = $500 (write off) + $150 depreciation* = $650.

*For simplicity, assumed depreciation life = 10 years

 

put it into the ato calculator and see what it spits out

Depreciation and capital allowances tool

 

The only issue with this is that if there's $500 left, it's likely to be in the low-value pool.

Con: you can't take anything out of the LVP once it's in there (including scrapping).

Pro: you can keep depreciating it (on top of the new unit), even though it's not present.

If you claim 10%, it means you're using the prime cost method of depreciation, and it's more likely you're using the diminishing value one (though, this is of course an assumption on my part).

That means that you're more likely to use a 20% compounding depreciation rate rather than a flat 10% p.a. for 10 years.

Also, you would have to pro rata the claim from the date of installation.

 

Hey gurus, it sounds like the ATO's guidance for replacing appliances is pretty black and white. On the other hand, I believe replacing carpet or painting walls in a house that has been tenanted immediately before the work is generally fully deductible? Would this extend to external and roof painting? My IP could do with a roof restoration one day.