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Knowing the difference between a rental property repair and an improvement can be a blessing in disguise for owners! With a whole host of tax deductions at your disposal, it’s a great way to bolster the returns on your investment property.
Recently though, the Australian Taxation Office (ATO) has cracked down on property owners after receiving a multitude of incorrect claims when it came to the end of the financial year. Just a few years ago, the problem was so out of hand that owners were claiming more than they earned.
According to tax commissioner Chris Jordan, more than two million taxpayers were claiming $47.4 billion in rental deductions, against $44.1 billion in reported income during 2017-18.
The ATO treats these terms slightly differently when it comes to tax deductions, but shockingly, the vast majority of property investors just don’t seem to be aware of the difference between rental property repair vs improvements.
Lucky for you, we’ve prepared a handy guide for spotting the difference between repairs, maintenance, and capital improvements. Best not to brush this one under the rug – knowing which is which could save you from being on the receiving end of a very stressful and lengthy audit
What counts as repairs and maintenance?
The easiest way to figure out what work falls under repairs and maintenance is to ask yourself: “Am I returning the property to its original state?”. If the answer is yes, then you can tick it off as either a repair or maintenance job.
There is a subtle difference between repairs and rental property maintenance. Repairs are about mending wear and tear, and damage, while maintenance looks at preventing or fixing deterioration.
Essentially, if you’re fixing something that’s “worn out, damaged or broken as a result of renting out the property” then it’s considered a repair.
Some common examples of repairs and maintenance include:
- Fixing leaking taps
- Replacing part of a storm-damaged fence
- Replacing a broken window
- Replacing part of the guttering
- Repairing an air-conditioner or other electrical appliances
Here’s a little story about Jim that might help make things a bit clearer:
After a night of severe thunderstorms, Jim, the owner of a rented property, received a call from his tenant alerting him that a tree branch had fallen and broken a portion of the property’s fence. Not only that, but other branches had smashed a couple of windows at the back of the house.
Jim quickly contacted some tradies and soon enough, the fence and the windows were back to their normal working condition.
What Jim did in this scenario is a prime example of repairs. But, if he had replaced the windows with better quality glass, or replaced the entire fence with a sturdier material, that would no longer count as a repair, but a capital improvement.
On the other hand, maintenance is not so much about fixing damage as it is about keeping the property in a tenantable condition by mending signs of deterioration.
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The price of standard maintenance jobs
Oiling a deck
Cleaning a pool
Gas water heater
Still confused about what maintenance is? Just read Ronda’s story:
At the end of a tenancy, Ronda, the property owner discovers that the carpet in the lounge room has taken on a fair bit of wear and tear, leading to some discolouration. Some doorknobs and cupboard hinges are also noticeably loose.
Ronda’s next step was to hire a carpet cleaner and a handyman to fix these issues. Since she’s only restoring things that have undergone natural deterioration, these fixes will fall within the definition of maintenance.
What counts as capital improvements?
Just like with repairs and maintenance, the easiest way to know whether the work you’re carrying out is a capital improvement is to ask yourself a simple question: “Am I improving the condition of the property to make it better than it previously was?”.
If the answer is yes, then consider it a capital improvement to your rental property.
Sounds like an easy enough way to figure this stuff out, right? That’s because it is! But here’s where it can get tricky - there are actually two types of capital improvements: Capital works and Depreciating assets.
What are capital works?
Think of this as any type of construction job where you’re improving or adding something to the property’s structure. Many property owners do this to improve the income-producing ability of their investment.
How to improve your rental property?
- Replacing a roof with better quality roofing
- Adding a room
- Major renovations like a new kitchenette
- Adding a fence to the premises
- Installing a driveway or retaining wall
- Replacing a structure that’s only partially damaged (e.g. fence, wall, flooring) with an entirely new structure
In each of these cases, making these capital improvements on a rental property adds more value than it had in its original state.
Let’s take another example and have a look at Ryan, a property owner who wants to modernise his kitchen so he can add a bit of value to his investment property. The addition of a new basin and tap set means that Ryan gets the contemporary style he’s after, but it also means that he’ll have to mark the expenditure down as capital work come tax time.
What are depreciating assets?
Let’s forget about construction for a minute. Depreciating assets are items that don’t end up forming part of the actual property but can be installed and removed with relative ease. These ‘plant assets’ also have a short life span, so they’ll need to be replaced within a relatively short period of time.
Some examples of depreciating assets are things like a new:
- Timber flooring
These types of capital improvements on a rental property can go a fair way in allowing you to bump up the weekly rental fee.
Here’s another hypothetical for clarity:
Before owner Saskia lists her property on the market, she wants to add a few touches that’ll bring in a bit more rent in hand each week. She completely strips the existing carpet and replaces it with a brand new woollen affair. She also goes to the effort of purchasing a new stovetop and dishwasher.
New additions? Yes. A permanent part of the property? Not so much. Because of this, Saskia will have to be mindful of marking those expenditures down as capital allowances on her next tax return.
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How are repairs and improvements taxed differently?
By this point, you’re hopefully pretty well informed on the difference between rental property repairs vs improvements. This handy piece of real estate knowledge will certainly set you up for success in lodging an airtight tax claim (and dodging a very unwanted audit).
Alarmingly, not knowing the difference between repairs and improvements was a large part of why 9 out of 10 property investors had their claims rejected by the ATO.
But you’re probably still wondering a couple of things, like how exactly those two are taxed differently, what tax rules apply to one or the other, and what are those rules anyway?
The big difference between repairs and maintenance, and capital improvements is that:
- Repair and maintenance expenses can be claimed in the same financial year in which you incurred them.
- Capital improvements have to be claimed over a number of years.
Let's take a closer look.
Claiming repairs and maintenance
When claiming repairs and maintenance, such as fixing a broken window or splashing a fresh coat of paint on some faded walls, you can go ahead and jot the full cost down as tax deductions on your tax return for that year.
Like many other tax-deductible items, repairs and maintenance costs are a simple way to offset your taxable income.
Let’s say you forked out $1000 in one financial year on a rental property painting repair - you could then claim the cost back against your $85,000 salary!
Just remember, if you want this claim to be on the up and up, your property must either be:
- Rented on an ongoing basis, or
- Remain genuinely available despite undergoing a short vacancy period
Claiming capital improvements
There’s a bit of a difference in the tax rules when it comes to capital works and capital allowances. You’ll want to make sure you’re using the right formula for each one if you’re going to make it through tax time unscathed.
Let’s start with capital works.
Say you’ve conducted a big construction job on your property. You can’t just claim the full cost of that work on your tax return for that single year. You’re going to need to spread the deduction over multiple years.
Rate of deduction for residential property capital works
Rate of deduction
18 July 1985-15 September 1987
16 September 1987-Present
But, just like repairs and maintenance, you can only claim this deduction if your property is rented out or genuinely available for rent. And only if the property was built after 17 July 1985.
For example, in 2020 Jenny decides to renovate her kitchen for $20,000 before leasing her property. She ends up renting out her property for a full year. With an expected life of 40 years, depreciating at 2.5% a year, Jenny can claim $500 ($20,000 x 2.5%) in capital works deductions for that financial year.
Importantly, Jenny can keep on claiming that $500 tax deduction for every year that her property is under lease, until 2060.
There are, of course, some finer details to consider - here’s a useful guide that might shed more light on the matter.
Let’s move on to depreciating assets or capital allowances.
When trying to work out the depreciation of a brand new asset, you can go about it in one of two ways:
- Diminishing value method – the decline in value each year is a constant proportion of the remaining value, hence, you are claiming higher deductions in the early years of its effective life
- Prime cost method – the decline in value each year is a uniform amount of the original value over its effective life, hence, you are claiming a lower but more constant proportion each year
In practice, the diminishing value method might look something like this:
Asset’s cost x (Days held / 365) x (200% / Asset’s effective life)
Asset’s cost x (Days held / 365) x (100% / Asset’s effective life)
If however you’ve bought a depreciating asset with a price tag of less than $300, then it’s good news! You can actually treat that as you would a repair or maintenance job and claim the full cost in the same financial year you purchased it.
Improvements or repairs: What’s better when selling?
We’ve said it before and we’ll say it again: you have to treat your property like a business. And as a business, the goal at the end of the day is always to make a profit. There’s no better time to put that mantra into practice than when you decide to sell!
While the Aussie property market is well-known for its natural ability to bolster capital growth, there are a few things owners can do themselves to inflate the value of their investment. That’s where capital improvements come in!
Before you spend tens of thousands of dollars on extravagant renovations, there are a number of smaller tweaks to consider that can go a long way in boosting the value of your investment.
- New flooring: Strip out those worn floorboards or that scruffy carpet and replace it with something fresh yet cost-effective like $30m² vinyl
- New window coverings: Get a fresh set of curtains or blinds ranging from $10 - $1000 (plus installation fees of up to $200)
- Upgrade taps: Be gone with those rusted and leaky fixtures and opt for a brand spanking new basin tap set for as low as $80
- Replace cabinets: Retire those aged cabinet doors that have seen better days and invest in an eye-catching new cabinet set for around $4000 (depending on the size of your kitchen of course)
Fancy the idea of ramping up your property’s price tag by 7%? Then it’s time to spruce up its curbside appeal!
- Landscaping: Fully fitting out that empty front yard with a vibrant array of flowers and fresh greenery for around $6000 can more than makeup for itself when you consider the value it can add to the sale price
- Outdoor sensor lighting: Boost the next owners' sense of security with a system that will illuminate the property’s entryways after dark - starting at around $120 per LED light (plus installation, $90 - $120 / hr)
- New fencing: Encasing your property in a freshly minted frame of Colourbond fencing for between $65 - $100 / m will do wonders for the overall aesthetic and security of your residence
While repairs are the surefire way to keep your property in good health and your renters happy throughout the life of the tenancy, it’s really capital improvements that will take centre stage when you want to up the value of your property come selling time.
With the ATO cracking down on owners lodging incorrect tax claims, it’s never been more important to know the difference between rental property repair vs improvement!
As far as your tax returns are concerned, repairs and maintenance cover all things damage and deterioration. The key thing being that with this kind of work, you’re only returning the property or the item back to its original state – not making it better, sturdier, or more valuable than it was before! You have full reign to claim the entire cost of these fixes as deductions in the same financial year in which you incurred the cost.
When it comes time to cash in on your investment and throw up that big ‘For Sale’ sign, just remember that it’s capital improvements that will do you justice in bumping up the value, not repairs. The trick is to figure out whether these improvements fall under capital work or a capital allowance.
Undertaking some major construction where you’re changing or adding something to the structure of the property? Consider it a capital work.
Fitting out the property with some brand new items that can be removed easily and will need to be replaced relatively soon? That’s a capital allowance.
Remember that tax wise, you’ll need to claim deductions for capital improvements over a number of financial years.
Knowing what tax rules apply to which rental property fixes is something every owner should be on top of - unless you want to get your tax claim thrown back at you and face the wrath of the ATO.
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Disclaimer: The views, information, or opinions expressed in this blog post are for general information purposes only and should not be relied upon. We have not taken into account specific situations, facts or circumstances, and no part of this blog post constitutes personal financial, legal, or tax advice to you. You should seek tax advice from your accountant, specific to your situation.