Improvements, repairs and maintenance. All sound similar but are treated differently by the Australian Tax Office (ATO).
When you buy an investment property, particularly a second-hand property, you’ll quickly find out that there are all sorts of costs that you’ll incur when renting out your investment property.
In general, first-time investors who aren't equipped with the necessary tax knowledge will either miss the opportunity to claim their repairs and maintenance expenses; or they confuse what constitutes improvements, repairs and maintenance when completing their annual tax return.
In a recent review, the ATO indicated that at least 9 out of 10 property investors were making mistakes on their claims with claiming expenses on rental properties as one of the top 5 mistakes that are commonly made during tax time.
So, we’ve created a guide that’ll help you distinguish between the types of deductions available to you for repairs and maintenance, including when and how you can claim this for the best tax benefits.
Before indicating what you can and can’t claim, it’s essential to understand what constitutes repairs, maintenance and improvements.
According to the ATO, repairing your rental property entails remedying some kind of defect or damage to your property.
In other words, repairs related to the general wear and tear of the rental property as well as any damage caused to the property as a direct result of renting it out.
Examples of repairs include:
The ATO defines maintenance as any work carried out to prevent deterioration of the investment property or to fix already existing damage.
Examples of maintenance include:
While a repair essentially restores something to its original state and maintenance prevents the property from deteriorating, an improvement upgrades and advances your investment property.
The purpose of making improvements to your rental property is usually to increase its market value or increase its ability to generate income.
Examples of improvements include:
You can claim the expenses related to the repairs and maintenance of your investment property as an immediate tax deduction.
In other words, you can claim these expenses in the same year that you paid for them.
It’s important to note that the claim for repairs and maintenance needs to have occurred during the period in which you rented it out.
Serena owns an investment property in Port Douglas, Queensland. To generate income from her property, she is currently renting it out.
In March 2020, her tenants called her to let her know that there was a severe storm over the weekend. There were a few roof tiles that were damaged as a result of the strong winds.
Serena called a local repairer to come and inspect the damage. After receiving his quote, Serena decided to go ahead with the repair.
Serena can claim that repair expense incurred on her 2020 income tax return.
You can’t claim the expenditure incurred from repairs and maintenance if it didn’t occur during the period in which you rented the property out.
For example, suppose you undertook a repair upon acquiring the investment property. In that case, it will be considered an initial repair and not deductible as repairs and maintenance.
An initial repair involves remedying defects, damage or deterioration that existed at the time you purchased the investment property prior to renting it out.
Instead, it’s considered a capital expense.
According to the ATO, capital expenses may form part of your property’s cost base for capital gains tax (CGT) purposes. By maximising your cost base, you should be able to minimise the capital gain once you sell the property: the less capital gain, the less CGT.
The best way to determine what expenses you can add to your cost base and how you can reduce the number of capital gains you declare would be to have us at Duo Tax Quantity Surveyor produce a Capital Gains Report.
Wendy purchased her first investment property in 2018, but it was a bit run down. Before she could advertise to rent it out, she needed to:
• fix the leaking bath;
• replace the shower;
• repair the air conditioner;
• have the house cleaned; and
• add a fresh coat of paint to all the interior and exterior walls.
But, all the repairs and maintenance work was performed before her investment property was available for rent. So, her incurred expenses form part of her initial property costs and can’t be claimed as an immediately tax-deductible expense.
The costs can be added to her cost base, which will be depreciated once the property is rented out.
For more on depreciation and how it can be beneficial for your tax return, check out our guide on what tax depreciation is.
You similarly can’t immediately claim the expenses incurred from making improvements to your rental property because it constitutes a capital expense. Improvements on the property can, however, still have some tax benefits.
Tax deductions for capital works are known as capital works deductions.
According to the ATO, improvements are classified as capital improvements, and you can claim 2.5% of the costs each year for 40 years from the date that the upgrades were completed.
You can, however, only claim for the years that the property is rented out.
A great way to determine how much you can claim each year is to have a quantity surveyor provide a free estimate or to purchase a tax depreciation schedule for you.
Joseph is currently renting out his investment property in Cronulla, New South Wales. Unfortunately, his tenants damaged the cement wall that separated the dining area from the lounge area.
Joseph saw this as an opportunity to knock the entire wall down and replace it with a feature wall made with bricks instead of solid concrete.
As Joseph opted to do more than restore the practical functioning of the wall, the costs incurred are not considered as repair expenses but instead as improvement costs.
Consequently, he can’t claim the cost as a ‘repairs and maintenance’ tax-deductible expense in his income tax return for the year.
However, he can claim it as capital works expense.
Suppose the bathtub in your rental property breaks beyond repair, for example, and you have to replace it entirely. If that is the case, the ATO doesn’t consider the replacement as a repair.
While you can’t claim it as an immediate tax deduction, you should be able to claim it as a capital improvement or as a depreciating asset.
To be eligible to claim repairs and maintenance as an immediate tax-deductible expense, the costs must directly relate to the general wear and tear of your investment property.
You can similarly claim any costs related to damages incurred from renting it out, as an immediate tax-deductible expense.
Understanding the difference between what constitutes repairs and maintenance and what constitutes an improvement is also essential when it comes to claiming tax deductions.
Unlike repairs and maintenance, improvements are not an immediately claimable expense, but you can claim a percentage of the cost over time as tax depreciation by engaging a Quantity Surveyor.
The table below provides a breakdown to help you determine the category of your rental property expense and how it should be claimed: