Deductions: repairs: is it capital?
One of the key considerations when deciding whether a repair is a deductible expense is whether it is revenue or capital. Here we will cover some of the more common repairs or improvements that will occur during a rental business.
Cost of land and buildings is capital
The cost of land and any buildings on it is capital expenditure. So is the cost of any new buildings erected after letting has started and any improvements. Capital expenditure cannot be deducted in computing the profits of a property business. Nor can a revenue deduction be claimed for the depreciation of capital assets or for any loss on the disposal of capital assets. But there are separate reliefs for some capital expenditure (see below).
Other examples of capital expenses include:
expenditure which adds to or improves the land or property; for example, converting a disused barn to a holiday home,
the cost of refurbishing or repairing a property bought in a derelict or run-down state,
expenditure on demolishing a derelict factory to clear space for a new office building; the cost of the new building,
the cost of building a car park next to a property that is let,
expenditure on a new access road to a property,
the cost of a new piece of land next to a property that is let.
When there is capital improvement
It is largely a question of fact and degree in each case whether expenditure on a property leads to an improvement.
Sometimes the improvement may be so small as to count as incidental to a repair. In the absence of other capital indications, the entire cost is then revenue expenditure.
Problems can arise where the customer does work on an old asset. A repair or replacement of a part of a building using modern materials may give an apparent element of improvement because of the greater durability, superior qualities and so forth of the new material. But the cost normally remains revenue expenditure where any improvement arises only because the customer uses new materials that are broadly equivalent to the old materials.
For example, the following are usually revenue expenses in the absence of any other capital indications. The cost of replacing:
wooden beams with steel girders, and
lead pipes with copper or plastic pipes.
There is likely to be capital expenditure if, say, the steel girders were designed to take heavier loads so that the building could take larger machines after the work was done. The same is true if the new pipes are designed to take greater pressure or heat.
But there is usually no improvement if trivial increases in performance or capacity arise solely from the replacement of old materials with newer but broadly equivalent materials. For example, the replacement of pipes or storage tanks of imperial measure with the closest metric equivalent may result in slightly increased diameter or capacity but the cost is still revenue expenditure.
Where a significant improvement arises from the change of materials, the whole of the cost is capital expenditure. This includes things like redecoration after the main work has been done (redecoration would ordinarily be a revenue expense). The entire cost is capital expenditure, including the expense of making good any damage to decorations.
Similarly, alterations due to advancements in technology are generally treated as an allowable repair rather than an improvement, if the functionality and character of the asset is broadly the same. For example, when single glazing is replaced with double glazing.
Extensive alterations to a property
Alterations to a building may be so extensive as to amount to the reconstruction of the property. This will be capital expenditure and it can’t be deducted as an ordinary revenue business expense. Rebuilding, whether forced on the customer or voluntarily undertaken, is capital expenditure and the whole cost can’t be deducted in computing profits. Only the actual cost of normal revenue repairs to a part of the old building that is preserved in the rebuilt structure is allowable as an ordinary revenue business expense. But:
capital expenditure may instead qualify in certain cases for capital allowances (see PIM3010 onwards), or
the whole of a payment is not necessarily either capital or revenue; it may be possible to split it between capital and revenue items (see below).
Capital work and revenue repairs at the same time
Work commissioned on a property may include expenditure on capital works and also separate expenditure on repairs at the same time. Here the expenditure on repairs remains allowable. Expenditure may be apportioned on a reasonable basis to estimate the amount attributable to the repair element. An apportionment in the contractor’s bill may provide a sensible basis for splitting the total; but it must be done fairly and the figures will be open to review if, say, capital expenditure is wrongly described as revenue expenditure on repairs.
Repairs after a property is acquired
Repairs to reinstate a worn or dilapidated asset are usually deductible as revenue expenditure. The mere fact that the customer bought the asset not long before the repairs are made does not in itself make the repair a capital expense. But a change of ownership combined with one or more additional factors may mean the expenditure is capital. Examples of such factors are:
A property acquired that wasn’t in a fit state for use in the business until the repairs had been carried out or that couldn’t continue to be let without repairs being made shortly after acquisition.
The price paid for the property was substantially reduced because of its dilapidated state. A deduction isn’t denied where the purchase price merely reflects the reduced value of the asset due to normal wear and tear (for example, between normal exterior painting cycles). This is so even if the customer makes the repairs just after they acquire the asset.
The customer makes an agreement that commits them to reinstate the property to a good state of repair. For example, Fred is granted a 21-year lease of a property in a poor state of repair by his landlord that he, in turn, sublets. When Fred’s landlord grants him the lease Fred agrees that he will refurbish the property. Fred’s expenditure on making good will be capital expenditure and not allowable. But Fred’s landlord may be chargeable on the value of the work under the premiums rules (PIM1200 onwards) and Fred may qualify for some relief (see PIM2230 onwards). See below if payments for dilapidations are made to the landlord at the end of the lease.
It isn’t necessary for all these factors to be present for the expenditure to be capital. The underlying principle is that the cost of buying a property in good condition is clearly capital expenditure. Hence the cost of buying a dilapidated property and putting it in good order is also capital expenditure.
Where the customer is granted a lease of a property in good repair, the expenses they incur in keeping it in that state will normally be deductible. This generally includes a payment they make to their landlord at the end of their lease on account of repairs which were due but which they had not made. These over-due repairs are called ‘dilapidations’.
Separate relief for capital expenses
In some cases capital expenditure on a property (but not the land itself) may qualify for ‘capital allowances’. These are effectively further deductions in arriving at taxable rental business profit. In particular, capital allowances are available for expenditure on certain industrial and agricultural buildings. Plant or machinery within buildings may qualify, for example lifts. Allowances may also be due on demolition costs. There are no capital allowances for the cost or depreciation of residential property; but there are special rules covering the replacement of domestic items (PIM3210).
There is more about relief for capital expenditure at PIM3010 onwards.