The truth about rental property repairs and claiming a tax deduction
A rental property should be treated like a small business. You need to monitor your cash flow, keep appropriate records, and know what you can and can’t claim as a tax deduction. For the majority of expenses, you don’t need to be Einstein to figure out what is tax deductible. Trying to work out the difference between a repair and an improvement, however, is not so black and white, and dare I say Einstein may have had a hard time differentiating between the two if rental properties existed back in his day.
It can also be a grey area of tax law, and a constant source of frustration for landlords who run off to undertake repairs and renovations to their properties, only to find out later that the expenses are not eligible for an immediate tax deduction. This is a long blog, but such an important topic, that it warrants the length of this article. So pull up a chair, grab a coffee and read on!
When will an expense be a repair, and more importantly when will it not?
According to the tax office a repair is work to make good or remedy defects in, damage to or deterioration of the property.
- Replacing part of the guttering or windows damaged in a storm
- Replacing part of a fence that got damaged in a storm
- Repairing electrical appliances.
- Repairing existing plumbing
- Repairing part of the roof
Maintenance such as painting, maintaining plumbing, and maintaining electrical work will also fall under the banner of a repair
Notice the examples above all have a repetitive element to them. They each highlight the fact that the work carried out was only to a small section of the asset. For example, a section of the entire roof, or a section of the entire fence. This is probably a good gauge. If you stop replacing sections of things or parts of things and suddenly start replacing the whole thing in its entirety, your gut instinct should tell you that you have jumped into asset replacement territory, and therefore the expense will no longer be classed as a repair.
A repair will turn into an improvement as soon as you start replacing the entire asset or changing the nature of the asset.
Examples of improvements are:
- Adding an additional room
- Replacing all existing plumbing
- Replacing all existing electrical wiring
- Renovating the entire kitchen
- Replacing an entire roof
Improvements will be treated as a capital expense by the tax office and should be depreciated over their expected life. Generally any improvements that form part of the house and cannot be detached such as a new roof, bathroom renovation or house extensions, can only be depreciated at 2.5% over 40 years.
Replacement of assets that are detachable from the house such as ovens, hot water systems, carpets and curtains can be depreciated at much higher rates depending on the asset and can even be claimed as an outright tax deduction if the asset cost is less than $300 (or $600 for joint tenants). If you want an indication of what your depreciation rate may be then I suggest you jump over to this Free Australian Tax Depreciation Rate Finder. I love this website. Just plug in the name of the asset and it instantly tells you the depreciation rate.
Commonly asked questions about repairs:
1. “I have just purchased a rental property. Can I do some repairs before the tenant moves in and claim a tax deduction?”
To claim an outright tax deduction for repairs and maintenance, the damages must have been caused by your tenant. If you have just purchased the property and never had a tenant in the house, then clearly you won’t have a leg to stand on. The good news, however, is that these expenses will be classed as capital, and you can depreciate them over their useful life.
2. “What if I purchase the house, let the tenant move in and then do the repairs six months down the track?”
A word of caution here. Be very careful about doing repairs to a rental property in the first 12 months after the property is purchased. The tax office closely monitors landlords with large repair claims in their first year of operation. The majority of the time these repairs actually relate to damage that was already evident when the landlord purchased the property. You can’t claim repairs as a tax deduction that were caused while under the watch of the previous home owner. The ATO will automatically reclassify these expenses as capital and you will need to depreciate them over their useful life.
3. “I have owned a rental property for 12 months. My tenant has just moved out, and I would like to do some quick repairs before the next tenant moves in. Can I claim the repairs as a tax deduction?”
You can claim repairs to a rental property while no tenant is living there, as long as the repairs relate to one of your previous tenants. In fact, it is very common for landlords to give the property a quick coat of paint and repair minor broken items in-between tenants. If the tenant is not jumping up and down for things to be fixed, waiting till they move out is probably the best time to do it.
4. “Is it possible to replace an entire asset in small bits progressively over several years, claiming each stage as repairs and therefore an outright tax deduction?”
For example, can you replace the entire fence by doing a section at a time over several years, and claim each section as a repair when the work is carried out? The answer is YES! Although, be warned this is a very grey area of tax law. If you’re interested in reading more on this topic, you can start at TR 97/23 Paragraph 43.
My final word
It’s imperative that if you’re planning on buying a rental property that needs some repair work and renovations done, that you visit an accountant to make sure you are clear on what is going to be tax deductible upfront in the year of purchase, and what will need to be written off over the life of the asset. These calculations can make a huge difference when crunching numbers to determine if the property falls into the range for an ideal investment property. It will also play a massive part in your decision regarding how much you’re prepared to pay for the property.
If you’re a do it yourself tax preparer, who loves taking control of your own tax affairs, then this is the tax ruling you need to get your head around if you want to start self-assessing whether an expense is a repair or an improvement: TR 97/23. If you’re having difficulty making a decision, then I suggest seeking a private binding ruling from the Australian Taxation Office. See my article on lodging private rulings.
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