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.
Table of Contents
What’s The Difference Between Repairs, Maintenance and Improvements?
Before indicating what you can and can’t claim, it’s essential to understand what constitutes repairs, maintenance and improvements.
What’s Considered A Repair?
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:
replacing roof tiles that were damaged in a storm;
repairing a broken air conditioner;
replacing a broken window; or
resealing a leaking bathtub.
What Constitutes as Maintenance?
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:
gardening and land maintenance.
What About Improvements?
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:
remodelling the kitchen so that the area is bigger and more open;
extending the size of the bedrooms;
adding a swimming pool and patio area; or
What Can You Claim on Your Investment Property?
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.
What Can’t You Claim on Your Investment Property?
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.
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:
Preventing deterioration to your investment property’s garden
John, who owns a rental property, has organised for a fortnightly garden service to mow the lawn trim the lawn edges and weed.
Repairs and maintenance
Repairing a leak in your investment property’s swimming pool
Sasha’s tenants reported a crack in the swimming pool. Upon further investigation, the local repairman found that there was a leak. Sasha approved his quote to complete the repair.
Repairs and maintenance
Replacing the wooden deck that had existing rot when the property was purchased
Abigail decided to repair the wood deck by the pool after discovering that it was damaged due to rot. She had to do this before advertising to rent it out.
Extending the main bedroom
To make his property more appealing to rent out, Luke decided to build on to the main bedroom to create a bigger space.
Replacing the air conditioner
The air conditioner in the lounge room of Michelle’s rental property was broken beyond repair, and she had to replace it entirely.
Having a quantity surveyor draw up a depreciation schedule will be to your benefit when determining what you can claim each year for the improvements you made to your investment property.
Duo Tax’s team of quantity surveyors can help you by providing you with the most affordable, convenient and aggressive tax depreciation schedules that will maximise the return on your capital works improvement, and keep more money in your pocket.
They can, similarly, assist you with a free estimate to distinguish between any repairs and maintenance expenses as well as improvement costs if you are unsure as to what you can or can’t claim.
Disclaimer: Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal or tax advice. You should, where necessary, seek a second professional opinion for any legal or tax issues raised in your investing affairs.
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Tuan Duong is an award winning Quantity Surveyor and leads Duo Tax Quantity Surveyors – Australia’s fastest growing provider of Tax Depreciation. Reach out to him directly on 0431 154 356 or email firstname.lastname@example.org