So, your rental property needs a little bit of work. The question is whether that work represents a "repair" or an "improvement" for tax purposes. This might mean the difference between paying for your holiday from your tax refund or deferring your holiday for a couple of years so it is important to get it right.

What does the ATO Say?

The ATO has issued guidelines for helping work out whether an expense is  a repair or a capital improvement:

  1. Is the thing being replaced or renewed an "important part of the structure" of the building?
  2. Is the work merely restoring the function of something "without changing it's character"?
  3. Is the replacement thing "new and better" than the old one?
  4. Does the replacement thing have "considerable advantages" over the old one?

There is a theme in these guidelines relating to new and improved but let's face it, a new front door will generally always be "newer and better" then the old one and may have "considerable advantages" over the old one yet there is little doubt that replacing it is usually always a repair and the cost is therefore fully deductible.

So where is the line and how can you maximise your tax outcome by staying within the guidelines?

The first point: Understand that the line is not fixed. It will be determined on a case by case basis depending on the facts of each case.

The second point: When the work is carried out is important. For the owner of the property pictured here there will be little doubt that the costs to bring the property up to a liveable standard will be capital if these repairs are needed before the property can be tenanted. That means that cost will then be depreciated over time rather than claimed as a tax deduction in a single tax year.

But if you have rented the property for a period of time and the damage pictured was done by the tenant's, then a full deduction may be allowable (less any insurance compensation).

The third point: Does the work improve the function, or change the character, of the property or any part of the property. This is perhaps the most important consideration because even if the damage here was done by the tenants if you improve or substantially change the character of the property then the costs may not be immediately deductible. For example; if you remodelled the layout of the interior walls to create a 4th bedroom, that would probably make all of the work capital and therefore you would write the cost off over time.

These points should be considered before committing to any major repair or capital cost and take advice if you are not totally clear on what they mean. With some thought you may be able to rearrange things to ensure you achieve the best economic outcome. We have seen most or all property investment mistakes before so let our experience help guide your decisions. Believe me, my mate the BBQ adviser is almost always wrong when it comes to these matters.

What is the Best Outcome - Short Term Tax Saving or Longer Term Rent and Capital Growth?

The focus of property investment is often on the immediate tax deduction and maximising short term tax savings. To achieve that outcome you would want to make sure everything you did fell within the definition of repairs and/or maintenance. But whether this provides the best longer term outcome is questionable. It may be in your longer term economic interest to take the opportunity to improve the property, say by turning it into a 4 bedroom house rather than a 3 bedroom house, and writing the costs off over time.

The answer to which is best will always be dictated by your specific circumstances. In general though, I would be prepared to say that in the example given above where one had the opportunity to create an extra bedroom and forego the immediate tax benefit of the "repairs" expense, then the longer term improvement in property value and rental yield should exceed the value of your short term tax saving. This is where some number crunching can help you make the right decision.

The final point: Ultimately it is our job to ensure you achieve the results you want to achieve. We have many property investment clients and staff specifically qualified in property analysis so my final point, is to pick the phone up and talk to us so we can run the numbers for you. There is no one set rule and at times the best outcome may be counter intuitive.

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