As we approach the end of the financial year, it’s a good time for property investors to review how they’re claiming investment property tax deductions, particularly when it comes to repairs and maintenance.
The ATO has identified several common mistakes in tax returns, particularly among those who own rental properties. One frequent error is claiming a deduction for repairs when the expense should not have been claimed as an outright deduction.
When it comes to investment property tax deductions, one of the most important considerations is whether the expenditure is of a capital nature. This distinction can be tricky and is often the source of incorrect claims.
Capital vs Revenue: Understanding Your Investment Property Expenses
A useful way to understand this distinction is through the classic example of the ‘fruit and the tree’. The tree represents the capital or the income-producing structure, while the fruit represents the recurring income.
Applied to rental properties:
- The structure of the property is considered capital.
- Ongoing expenses that don’t add to this structure are typically on revenue account and may be immediately deductible.
As a general rule, capital expenses need to be written off over time, while eligible repairs and maintenance can often be claimed as immediate investment property tax deductions.
Example:
A burst water pipe is repaired by a plumber who replaces part of the pipe and performs related tasks. This restores the property to its original state and is not a capital improvement. Therefore, the cost is immediately deductible.
Example:
Several water pipes burst, and you decide to replace the entire plumbing system. This is a capital expense, as the whole system has been replaced. The cost must be depreciated over time, as capital works, usually over 40 years.
Initial Repairs & Investment Property Tax Deductions
Another common mistake when claiming investment property tax deductions relates to initial repairs. These are expenses incurred to fix damage or defects that existed at the time the property was purchased.
If you repair items that were already in disrepair when you bought the property, these costs are not immediately deductible. Instead, they are considered part of the property’s acquisition cost and must be added to the cost base for capital gains tax (CGT) purposes. You may receive a tax benefit from these expenses when you eventually sell the property.
Example:
You purchase a rental property with damaged kitchen cabinets. If you repair or replace them before the property is first rented out, the expense is classified as an initial repair and not deductible now. However, it can be added to your cost base for CGT purposes.
Repairs vs Improvements
Another key consideration when claiming investment property tax deductions is whether your expense is a repair or an improvement.
When repairs involve new materials, deductibility depends on whether the item is restored to its original condition or upgraded. An upgrade is considered an improvement and is not immediately deductible.
Example:
You replace a section of damaged roof tiles with similar materials. This is considered a repair and is deductible.
Example:
You replace the entire roof with modern, more durable materials. This is a capital improvement and must be written off over time.
Whole Item vs Part Repairs
You also need to consider whether you are repairing part of an item or replacing the whole item. If the entire asset is replaced, it is generally a capital expense and not immediately deductible.
However, this area can be complex and context matters.
Example:
You replace the entire roof with materials of similar quality. If the ATO accepts the view that the “entirety” is the house itself (not the roof alone), then this cost may be deductible as a repair.
Depreciation and Second-Hand Assets
Finally, when assessing investment property tax deductions, it’s important to remember the changes introduced for second-hand assets:
- If you purchased the rental property on or after 9 May 2017, you cannot claim deductions for the decline in value of second-hand assets already in the property.
- If you converted your home into a rental on or after 1 July 2017, you can only claim depreciation on new assets you’ve added since making the change.
Maximise Your Investment Property Tax Deductions Before EOFY 2025
Getting your claims right is essential. Repairs, improvements, depreciation, and initial expenses are all treated differently under tax law—and mistakes can be costly.
At MacMillan Cowan & Co, our team can help you navigate the details and make sure your investment property tax deductions are accurate, compliant, and working for you this tax time.
To make an appointment, please call our office or contact us online.