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My question relates to initial repairs and how the ATO classifies an inherited property.
Our ancestral home in Qld was bequeathed to me in May 2021, and the title was transferred the following November. I was initially undecided as to whether I should sell the property or lease it out, as I currently live interstate. I eventually decided to lease out the property, but Covid restrictions meant that I was only recently able to travel up to clear out the house and make it available for rental.
Both rental agents that I interviewed advised that I would need to install ceiling fans in order for it to be a viable rental property. I have also needed to upgrade some plumbing fixtures, have the kitchen painted and new carpets installed. My understanding is that the rules surrounding Initial Repairs means that any repairs or improvements, even those required by law to to bring the property up to code (e.g., legislation regarding smoke alarm systems changed 2 months after I received title) must be claimed as capital works, not deductible expenses. I’m assuming that for all intents and purposes, the ATO would regard these upgrades in the same manner, despite that fact that technically, I did not purchase the property, but chose to convert it to an income-producing asset. Can you confirm please? In the interests of clarity, I officially contracted a rental agent for the property prior to undertaking any of the works and have been depositing the funds into the agency’s trust account to pay the invoices.
However, what would be the ruling be in regards to the Deceased Estate Clearance costs? It cost approx $3500 to have a firm remove all the old furniture and personal possessions, before the property could even be cleaned and made available for rental. I have also had a pest inspection and treatment done, and the hot water heater serviced. Would these (along with cleaning) be deductible expenses? The property is advertised and tenants are currently being interviewed. Should I wait until tenants have moved in before having gardening completed, or will it make no difference in terms of deductibility? Thanks in advance.
Answer
Great question, thanks for allowing it to be published as knowing the difference between repairs, plant and equipment, initial repairs, capital improvements and the CGT cost base is a complex issue
But firstly, regarding the fact you inherited the property. If it was covered by the deceased’s main residence exemption or was a pre 19th September, 1985 asset to the deceased then you have inherited it with a cost base of the market value at DOD. Be careful with the pre 1985 issue. The deceased may have originally owned it with their spouse and inherited their spouse’s half after 1985.
If it was neither pre 1985 or the deceased’s home then you inherit it at the deceased’s cost base which would probably be the market value when they inherited plus any costs they have incurred in relation to it that they have not claimed as a tax deduction. I am assuming by the words ancestral home it has been in the family for many generations.
Having got your cost base from the information above many of the expenses the estate or you have incurred after DOD can increase that cost base. Even just the rates and insurance while holding it, this would include the period before you had the chance to clear it out but the costs of clearing it out are a private cost as would be any cleaning in order to get it ready for rent. Rates and insurance etc after it is ready to rent out and listed would not increase the cost base because they would become tax deductible.
As for the work you have been doing on it there would be no initial repairs as such but don’t worry too much about that as the outcome will be the same. We are looking to split your expenses into plant and equipment that you can depreciate under Div 40 these are generally identified as things you have replaced in their entirety and can be removed from the house without damage. For work to be a repair something of the old must remain. The fans and carpet would be plant and equipment so you can depreciate them over their effective life and if the property is being used to produce income during that time the depreciation will be tax deductible. The effective life for fans is 5 years and carpet 8. Here is a link to the ATO’s rental property guide https://www.ato.gov.au/uploadedFiles/Content/IND/Downloads/Rental-properties-2021.pdf which shows you at the back the effective lives for all sorts of plant and equipment. Plant and equipment that has been depreciated is not included in the CGT cost base. The capital works column, in the guide, ticks off items that are not plant and equipment, generally those items are subject to depreciation under Div 43 over 40 years as special building write off. Div 43 expenditure is included in the CGT cost base though at the time of sale the cost base will need to be adjusted for any building depreciation you have claimed.
Repairs can be included in the CGT cost base if they have not been claimed as a tax deduction. But repairs cannot qualify for Div 43 depreciation unless they are initial repairs. Initial repairs are considered a capital cost because they improve the asset beyond the condition it was originally purchased in. Otherwise repairs take on the nature of how the property was used in the year the repair was undertaken. If a repair directly related to private use or at least years when the property was not used to produce income then it is not a cost of earning income so not tax deductible (but can be used to increase the cost base). If the property was only used to produce income part of the financial year then the repair costs would be claimed pro rata. Though the ATO will try to argue that the repair became necessary years ago while it was not used for rent and was necessary to make the place suitable to rent so at a point to soon to be deductible. This is where plant and equipment has an advantage, each year you can evaluate how that year’s depreciation is claimed by how the property has been used. The used to produce income requirement is pretty strict these days. It has to be actively listed, in that potential tenants could inspect and move in that weekend.
So in answer to your question:
- Carpet and fans – you will miss out on claiming some of the depreciation for the early days before it was ready for rent. But after that you will be fine.
- Upgrading plumbing fixtures – As these can’t be easily removed without damaging the house these are not plant and equipment. They either a repair, if they needed fixing so limited to a pro rata claim based on how the property was used that year or an improvement if they did not need repairing and that will come under Div 43, depreciated over 40 years, claimable only of course for the period when the property is used to produce income.
- Painting the kitchen – is a repair but to be deductible there would have to be income earned in that financial year and the claim would have to be apportioned for the period it was not ready to produce income in that year.
- Pest control and the hot water service – would be repairs (and maintenance) but to be deductible there would have to be income earned in that financial year and the claim would have to be apportioned for the period it was not ready to produce income.
- Regarding the garden – I would not just wait until the tenants move in but also until 1st July ticks over so there is no need for apportionment.
Reference TR 97/23
