Many of our clients have investment properties, and it is important that we deal with associated expenditure in the correct manner.
Is usually partial and restores something to its original condition, such as by replacing part of a deck with new boards.
Is work that prevents deterioration or fixes current deterioration, this would include such things as re-sealing the deck, or oiling door hinges.
Repairs and maintenance must relate directly to wear and tear or damage that occurred due to renting out the property. The ATO lists the following repairs and maintenance for which clients may claim an immediate deduction in the same year:
- Gardening and lawn mowing
- Pest control
- Servicing a water heater
- Replacing guttering damaged in a storm
- Replacing part of a fence due to a fallen tree
Makes something better than it was originally or provides something in a new and more valuable or desirable form. Improvements typically improve the property’s income production or expected life. A repair becomes an improvement when clients go beyond simply restoring an item to its original state, such as replacing an old wooden deck with a concrete one, in this case the client has gone beyond simply restoring (repairing) the deck – they have improved with with more permanent (better) materials.
The ATO lists the following as improvements:
- A new stove
- New kitchen cupboards
- Building a garage or carport
- Removing or adding an internal wall
The different tax benefits between repairs, maintenance and improvements
Generally, clients can claim an immediate deduction for repairs and maintenance in the same financial year, as long as the property is being rented out.
Generally, clients can claim capital works deductions or depreciation deductions for the decline in value (depreciation) of improvements over a number of years.
The ATO lists the following examples depreciating improvements vis a vis capital works deduction:
- Ceiling fan (depreciated over 5 years)
- Carpet (10 years)
- Floating timber floors (15 years)
- Hot water system (12 years)
- Window curtains (6 years)
- Dishwasher (10 years)
- Air conditioner (20 years)
Capital works deduction
- Fixed floor coverings, such as tiles and vinyl
- Grease traps
- Hand rails
- Ducts, pipes, vents
Newly Acquired Properties
When clients purchase investment property, there are often items that need repairing before you can lease the property out. These are so-called “initial repairs”. Expenses to remedy these pre-existing defects are not deductible. Instead, they are considered part of the acquisition costs of the property and may be included in the capital gains tax cost base.
SMSFs making repairs or improvements
Typically SMSFs acquire investment properties through a bare (security) trust with a limited recourse borrowing arrangement (LRBA) in place, or by direct investment solely or jointly without any borrowing or security in the name of the SMSF.
Properties purchased with SMSF borrowings
If the SMSF’s property was purchased using borrowed money and the borrowing remains outstanding, then the client cannot use the borrowed funds to renovate (improve) the property. Instead, borrowed funds can only be used to repair the property.
SMSFs can however use money already accumulated in the SMSF to improve a property even if the property was purchased using borrowed money, as long as the improvement does not result in the property becoming a different type of asset. For example, an SMSF could add a deck, a swimming pool or new rooms and the property would still be a residential premise. However, improvements that changed the nature of the residential property, such as by converting part of it into a shop would not be allowed.
Properties purchased with SMSF accumulated funds
If the SMSF’s property was purchased using money accumulated in the SMSF, then there are no restrictions on renovating the property. The SMSF could even demolish the property and build a new property or properties on the land owned by your SMSF. However, the trustees should carefully review the SMSFs investment strategy to ensure that it allows for this endeavour; and, secondly the trustees or related parties should not undertake the work themselves unless they are licensed and qualified to do such work (generally they would need to be providing the same kind of services to the general public through a business).
Furthermore, if trustees or related parties are in the building industry, then the building materials should be purchased by the SMSF from third parties and not from the trustee/related party. Any labour provided by the trustee/related party must be paid at the commercial rate, or risk having the increase in the market value of the renovated property be treated as a personal superannuation contribution.