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The AAT has held that certain expenses incurred in regard to extensive water damage to a taxpayer’s rental property were to be allowed as deductions on the basis of the evidence of the carpenter who performed the work, which enabled the AAT to ascertain what constituted repair and what constituted improvement.

In 2008 the taxpayer began renting out a property he had purchased in 1983. After being happy with his first 2 tenants, in 2014 the third tenants absconded after only 2 months, in breach of the lease and owing rent. The taxpayer’s evidence was that, just before leaving, the third tenants deliberately blocked water drainage in the showers of the main bathroom and ensuite, plugged the bath in the main bathroom, plugged the sinks in both bathrooms as well as the kitchen sinks, and turned on all the taps, causing significant damage to the kitchen, ensuite, main bathroom and adjacent toilet and laundry.

Some repair works were immediately undertaken to the bathrooms and kitchen and the property was leased out again. However, during a fifth tenancy between September 2015 and September 2017 the shower head was broken off the wall of the ensuite resulting in the flooding of that room, and the flexible water pipe under a sink burst flooding the main bathroom, toilet and laundry.

The taxpayer claimed deductions for expenditure of $53,226 in the 2018 income year under s 25-10 of ITAA 1997 for work undertaken repairing the damage to the bathroom, ensuite, toilet, laundry and kitchen. The Commissioner disallowed the deductions and the taxpayer objected, then sought review by the AAT of the Commissioner’s objection decision.

The taxpayer’s case was that the expenditure was for repairs, not of a capital nature and not an improvement. He submitted that the work undertaken was all within the existing footprint of the rooms and that, apart from more contemporary fittings being installed, none of the repairs did more than restore the efficiency of the property’s functions. The Commissioner’s position was that the expenditure was capital in nature because the works amounted to improvements, contending that whether the refurbished rooms performed the same purpose or were laid out as previously was not determinative.

The evidence of the carpenter who carried out the majority of the work was that both bathrooms “had suffered from significant water ingress both to the fittings within the bathrooms … as well as structural damage to the floor, walls and ceiling” and that the “only way to fix the bathrooms properly was to remove the fittings, wall sheets and ceiling” and then re-waterproof. His involvement in the kitchen was to remove the existing cabinetry, which was “beyond repair”. New kitchen cabinetry was installed by a specialist kitchen firm.

The AAT partly upheld the taxpayer’s claims, remitting the objection decision under review to the Commissioner for reconsideration.

The AAT accepted the evidence of the carpenter that significant damage had occurred to the stud walls and floor of the kitchen, bathroom, ensuite, laundry and toilet due to the water ingress. To examine the damage, it was necessary to remove the wall coverings including much, if not all, of the wall tiles in the bathroom and ensuite and to a lesser extent in the toilet and laundry. This work was necessary, was a repair and was not in the nature of an improvement. Additional work done in reinstating the walls to their previous condition had little impact on the rental value of the house, with any improvement marginal. The cost of the materials in respect of these works was to be allowed.

The AAT found that the bathroom, ensuite and kitchen were completely rebuilt with contemporary new fittings and cabinetry. The result was that each of the 3 rooms had been refurbished and modernised, which must have improved the condition of the property from what it was before the water damage. Expenditure of $28,342 spent on materials renewing those 3 rooms was properly considered as capital expenditure, while expenditure of $2,819 on other materials were for repairs and were to be allowed as deductions.

In regard to the labour costs, the relevant invoices did not enable amounts to be quantified as to what was incurred on repairs and hence deductible and what was not. The AAT ordered that labour invoices totalling $22,064 were to be remitted to the Commissioner in order to make the appropriate apportionment in accordance with Taxation Ruling TR 97/23.

Source: Wulf v FC of T 2022 ATC ¶10-646; [2022] AATA 3094, 21 September 2022.

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