Tax Tip 206: What are ‘initial repairs’ and why they are not deductible?

‘initial repairs’ are repairs to a property to rectify damage which was already present at the time the property was acquired.

In TR 97/23 the ATO state:

“5. A repair is not an 'initial repair' simply because it is the first repair made after property is acquired. It is an 'initial repair' if repair is due when the property is acquired in the sense that the property has defects, damage or deterioration or is not in good order and suitable for use in the way intended.”


The ATO consider ‘initial repairs’ to be capital in nature, para 59 to 61


Normally repairs are deductible under s25-10 ITAA97, but subsection 3 of s25-10 says:

“(3) You cannot deduct capital expenditure under this section.”


Therefore costs to rectify damage that was already present at the time the property was purchased will not be deductible.


Example

Lisa buys a property which has some leaking pipes in the bathroom which has caused some damage. Lisa only found this out a few days after settlement when she took a shower. She did not know about the problem at purchase, but it existed before she bought the property.

Lisa arranges repairs to the pipes and replaces part of the bathroom floor and it ends up costing her about $10,000.

Can Lisa claim this $10,000 as a repair under s 25-10 ITAA97?

This to me sounds like it is an initial repair because it is a defect which existed at the time Lisa purchased the property. The fact that she did not know about it doesn’t change this*.

It is unlikely it would be deductible as a repair.

However, it might be possible for Lisa to depreciate this amount as building works.


* see paragraph 61. “It is immaterial whether at the time of acquisition the taxpayer was aware of the condition of the property, including its need for repair. It is also immaterial whether the purchase price (or lease rentals) reflected the need for repairs.”



See

Section 25-10 ITAA97

INCOME TAX ASSESSMENT ACT 1997 - SECT 25.10 Repairs

and

TR 97/23: Income tax: deductions for repairs

Legal Database

 

There are numerous cases (and appeals) on initial repairs. Even an issue not evident when the property was acquired and not shown on a P&B report and only detected after some time may fall foul of this issue. A common one is termite and structural / roof repairs or sewer issues. Others can be defects like windows etc which are needing rectification before an initial tenancy.

We often encounter the issue of initial repairs for a newly acquired IP. I would argue 8 out of 10 newly acquired properties experience this issue and need guidance.

Common question is : Can we defer the repair cost until the tenant is in ?
No. The ATO will see through this and consider the repairs existed prior to that tenant. Only repairs attributable to the period of tenancy are deductible repairs. Repainting for a first tenant is a initial repair for a newly acquired IP for example.

 

Thanks for all the great tips Terry.

We have recently bought a house in NSW which is subject to existing tenancy. The tenant has been there for over 5yrs and we will keep them on for at least a few months after settlement.

The house needs a number of repairs (new windows, fixes to the roof, etc). Would these repairs be classified as 'initial repairs'?

TIA
Steve

 

likely I would think as the repairs existing at purchase.
Go through that tax ruling carefully, and get tax advice, and see as it will depend on the item and exact circumstances.

 

A property with an existing tenancy spanning the sale can in some instances avoid the initial repairs rules for tenancy wear tear and damage rather than property damage eg repaint vs a old and broken window. However a private ruling is wise. ATO will expect evidence of a tenancy spanning the settlement. Have had clients claim repainting etc under this basis. Just as costs can come prior to income under steele's case the matching basis can also see costs deferred until a lease ends and that is the contention to put to the Commissioner. This is lawfully contracted and the wear and tear passes to the buyer as does the lease etc. The former owner cant do repairs while tenanted.

 

Thanks @Terry_w and @Paul@PAS.

What would be the approx cost of getting tax advice and obtaining a private ruling on this?

Thanks
Steve

 

Depends. If you can explain it well yourself its free. ATO will call and ask for extra info or clarrify anything. Practitioner support is often needed for particularly complex matters. I dont see this as complex.

Key question will be : Are these expenses initial repairs?
Breakdown into the relevant types of work. Thse evident related to past tennacy and those which are less evident.

Private rulings

 

worth a shot at a self applied for ruling

 

Thanks @Terry_w. I actually had a look at applying for a ruling today. Will give it a shot.

Do you know how long it typically takes?

 

Its supposed to be 28 days, but could be twice as long

 

It depends. If the information provided is complete then it could be under 28 days. Each time they ask it can extend.