Tax implications of Improvements v Repairs on a rental property
Repairs and improvements made to a rental property or shed you own may sound very similar however their respective tax treatment is very different.
Many taxpayers find the topic of repairs versus improvements difficult to understand particularly when it comes to what can be claimed as immediate deductions or what must be capitalised when maintaining or renovating a rental property or asset. The confusion stems from different types of expenses involved in the process of renovating or improving an asset and there needs to be a clear distinction in the understanding of ‘repairs’ and ‘improvements’ in order to overcome this.
Firstly, repairs generally have the characteristic of prolonging and keeping the asset or property in its existing state by taking actions to address damage, deterioration or defects. Repairs and maintenance have three key components listed below;
- They keep the property or asset in a normal operating condition
- They conserve the property or asset through routine maintenance
- They do not materially adjust the value of the property or asset.
Examples of repairs on rental properties include replacing curtains or painting a damaged section of a wall. Repairs of this nature are generally tax deductible and an immediate write off is permitted to the value that was spent for the repairs.
Improvements on the other hand are characterised by significant or substantial replacement or reconstruction of aspects of a property or asset and are generally capital in nature and therefore not immediately deductible. Improvements have a few more key components that separate these costs from repairs, which include;
- They add material value to the property or asset
- They prolong the useful life of the property or asset
- They restore or adapt the property or asset into a ‘like new’ condition
- They improve the capacity, productivity or efficiency of the property or asset
Examples of improvements on a rental property include replacing a stove top or extensions to the property.
So how do repairs and improvements then differ in their tax treatment?
Repairs and maintenance can be claimed to the full value that was spent in the year the cost was incurred. This means that if you spent $500 on replacing curtains in a rental property in August 2020, you will be able to claim the full repairs cost of $500 in your 2020/21 tax return. Capital improvements that cost less than $300 can also be claimed in full in the respective year the cost was incurred. Capital improvements that cost more than $300 must be capitalised and depreciated over time, with only a portion of their cost claimed in the year the cost was incurred. For example, an extension to a property cost $20,000 with an effective life of 40 years and will be depreciated at 2.5%, meaning that each year a capital works deduction of $400 can be claimed.