Repairs to rental properties not deductible?
A recent technical decision summary (TDS 24/02) issued by Inland Revenue involves a dispute with a taxpayer that purchased several residential rental properties. Soon after purchasing, the taxpayer conducted renovation work on the properties to various degrees, such as replacing kitchen units and
carpet, adding dishwashers and heat pumps, and cleaning and repairing roofs.
Inland Revenue concluded that the capital limitation applied to the costs involved with the work completed, on the basis the renovation costs formed part of the cost of acquisition of the properties, and the work completed was beyond ordinary repairs and maintenance. The key facts considered in coming to this conclusion were the condition of the properties when purchased, whether the purchase price was discounted, and the cause of the need for the work. It
was found that the properties were in average condition on purchase, and that the taxpayer renovated them to make them more attractive to higher paying tenants. This led Inland Revenue to assert that the purchase price was therefore discounted, as the vendor could have obtained a higher price had they conducted the repairs themselves before sale.
The taxpayer argued that the work was done to restore the properties to their original condition, with no real improvements being made. They asserted that the properties were fit for purpose at the time of purchase, evidenced by the fact that all but one property was tenanted. The less-than market purchase price was due to the fact that multiple properties were being purchased at once, hence a single transaction discount applied. Moreover, the taxpayer had attempted to negotiate a lower price with the vendor at the time of purchase due to repairs being needed but was unsuccessful. The taxpayer asserted that the photos Inland Revenue relied on to prove that the properties were unfit for purpose were not representative of the condition of the properties as a whole, as the taxpayer had
used these selected photographs for negotiation purposes.
This has been a topic well covered by previous case law, but one that easily lends itself to interpretation. In this case there is room to disagree with Inland Revenue’s interpretation. One would have to assume that price is always impacted by the condition something is sold in. If one were to take a literal interpretation of the Inland Revenue’s view, any subsequent repairs made to a recently purchased asset would point to a discount being received on the purchase price and should therefore be treated as capital in nature.
Clearly there is a fine line to traverse in such situations, and we may not have seen the last of this particular case if the taxpayer takes the matter further.