Are these things tax deductible?

This month I will outline a couple of questions that clients have raised during the tax season which might be helpful to you when determining the deductibility of expenditure incurred on your properties.

I have outlined two different topics of interest as follows:

1. What happens if the builder who built your investment property unit goes bankrupt and you are forced to incur expenditure on compliance costs and building repairs?

We recently had a client who experienced this situation and they incurred the following costs in relation to the building:

1. Fire system compliance certificate for the building
2. Legal fees to begin legal action against the insurance company
3. Insurance works carried out as per a special meeting convened by the strata meeting
4. An engineer’s report to identify defective building works
5. A safety audit report to enable the building to become compliant

The questions that the client had were:

• Are these costs deductible?
• If not can they be capitalised and then depreciated?
• Could the cost be apportioned between repairs to bring the building to a compliant state with the difference being capitalised and depreciated?

Our researched answers were not that favourable for the client and can be summarised as below:

Items 1, 4 and 5: These costs are most likely to form part of the cost base of the property. A deduction may be available for capital works under Division 43 of the ITAA 1997. TR 97/25 indicates that for the purposes of a capital works deduction, construction expenditure includes preliminary expenses such as architect fees, engineering fees, foundation excavation expenses and costs of building permits. Therefore, the same principle may apply to the cost of a fire system compliance certificate, engineers report and safety audit report.

Item 2: The legal fees would also form part of the cost base of the property as it appears to be capital in nature. The general rule is that the nature or character of legal expenses follows the advantage that is sought to be gained by incurring the expense.

Item 3: This again is most likely to be capital in nature and forms part of the cost base of the property. TR 97/23 provides guidance in relation to deductions for repairs and the ATO is of the view that initial repairs are of a capital nature and not deductible.

2. What repair cost are tax deductible?

We also had a client whose investment property incurred severe storms earlier this year. In addition to this, the tenant failing to maintain the yard area as required resulted in repairs being required to the rear and side yard of the property.

The questions that the client wanted us to research were whether these costs were deductible. Please note that in this case the client had already owned the property for four years:

1. Repair retaining wall at rear of house by providing 1200mm high wall in lieu of current 600mm wall
2. Regrade slopes at sides of the house that have been washed away by rain
3. Provide rock & gravel beds at sides to prevent further wash-away during rain
4. Scrape top soil from yard area to remove overgrown weeds and rubbish left by tenant
5. Replace the top soil that had washed away, as well as the soil removed by the scrape
6. Resow yard area with lawn seed to re-establish original lawn
7. Reinstall stormwater pits below ground level to allow drainage of storm water
8. Repairs to fence and front garden damaged during access for the above works

Our reply to the client in relation to this is as follows:

Item 1: We had to inform the client that they would unlikely be able to claim an immediate deduction for the cost of the retaining wall if the wall was replaced with a different length. In Case S13 85 ATC 171, two retaining walls were built on a rental property to prevent soil erosion.  Following storm damage, the walls were replaced in a different location with walls that were higher, stronger and of different material. The expenditure incurred for constructing the new walls was held to be an improvement to a fixed capital asset and not repairs.  However, we did inform the client that they may be able to claim a deduction for capital works under Division 43 of the ITAA 1997.

Items 2, 4 & 5:  We informed the client that these would be deductible as repairs if the works were done to bring the property to its previous condition.

Item 3:  The client was informed that it was most likely to be considered to be a capital improvement as the client was not restoring the property to its former efficiency but improving on that efficiency. Therefore, the expense would form part of the fourth element of the cost base of the property.

Item 6:  We informed the client that this should be able to be claimed as a deduction for the cost of resowing the yard area as repairs if they resowed the lawn in order to restore it to its previous condition.

Item 7:   This is similar to item 1 and we informed the client if they had reinstalled the stormwater pits at a different location, then it would be treated as an improvement and an immediate deduction would not be available.

Item 8:  We informed the client that item 8 could be claimed as a deduction for the fence depending on the extent of work carried out. If the client was simply repairing the fence to bring it back to the original condition, then an immediate deduction may be available. However, if they were replacing the entire fence, then that would constitute an improvement.

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David Shaw is the CEO of WSC Group: Certified Practising Accountants and Business Advisors, and was voted Property Tax Specialist of the Year in the Your Investment Property 2013 Readers Choice Awards (runner up in 2012 & 2014 ).

The above information is supplied by WSC Group.

Disclaimer: while due care is taken, the viewpoints expressed by contributors/sponsors do not necessarily reflect the opinions of Your Investment Property.