What are capital expenses
Capital expenses are expenses that provide long-term benefits to your property. These costs typically improve the property's value or extend its useful life. For example, installing a new roof, upgrading appliances, or adding a deck are capital expenses. They differ from regular operating expenses, like repairs and maintenance, which are typically short-term and recurring.
Capital expenses includes capital works and depreciating assets. These expenses are claimed over several years, rather than being deducted in the year they are incurred.
For a summary of the difference between repairs, maintenance and capital expenses, see Rental properties – repairs, maintenance and capital expenditure.
Capital works
Capital works includes expenses for building the property as well as structural improvements, alterations and extensions to the property. The rate of deduction for these capital works is generally 2.5% or 4% per year, spread over a period of 40 or 25 years respectively.
You can only claim a deduction for the capital works on rental properties if the property:
- was built after 17 July 1985
- is rented or genuinely available for rent.
An asset that is fixed to, or otherwise part of, a building or structural improvement, will generally be a construction expense and can only be claimed as capital works.
Preliminary expenses such as architect fees, engineering fees, surveying fees, foundation excavation expenses and costs of building permits also form part of construction expenses.
Examples of capital works expenses include:
- building and construction costs
- alterations to a building
- major renovations to a room
- substantial renovations to a property
- adding a fence
- building extensions such as garages and patios
- adding structural improvements such as a driveway or retaining wall.
You must wait until construction is complete to claim a deduction. Capital works deductions can't exceed your construction expenses.
Example: replacing assets in a residential property
Janet has owned and rented out a residential property since 12 January 1983. In 2024, she replaced the old kitchen fixtures, including the cupboards and appliances. The old cupboards had deteriorated through water damage and wear and tear.
The kitchen cupboards are separately identifiable capital items with their own function. This means the cost of completely replacing them is a capital cost. Because of this, Janet can claim:
- capital works deductions for the construction cost of this work
- deductions for the decline in value of the new kitchen appliances (none of these appliances were previously used).
This is the case regardless of whether:
- new fittings are of a similar size, design and quality as the originals
- new cupboards are made from a modern equivalent of the material used in the originals
- layout and design of the new kitchen may be substantially the same as the original.
Improvements
An improvement is anything that makes part of the property better, more valuable, more desirable or changes the character of the item that is being worked on.
Capital improvements (such as remodelling a bathroom or adding a pergola) should be claimed as capital works deductions.
Improvements include work that:
- provides something new
- furthers the income-producing ability or expected life of the property
- goes beyond just restoring the efficient functioning of the property.
Improvements can be either capital works where it is a structural improvement or capital allowances where the item is a depreciating asset.
Example: property improvements
Tim replaced a fibre cement sheeting wall inside his property because it was damaged by tenants. He replaced the old wall with a brick feature wall.
The new wall is an improvement because Tim did more than just restore the efficient function of the wall. This means Tim can't claim the cost of the new wall as a repair, but he can claim it as capital works deductions.
If Tim replaced the fibro with a current equivalent, such as plasterboard, he could have claimed his costs as a repair. This is because it would have restored the efficient function of the wall without changing its character, even though a different material was used.
End of exampleSubstantial renovations
Substantial renovations of a rental property are where all or substantially all, of a building is removed or is replaced. This could include the removal or replacement of foundations, external walls, interior supporting walls, floors, roof or staircases.
For renovations to be substantial, they must directly affect most rooms in a building.
Renovations you make to a house are considered collectively, such as the:
- removal and replacement of the exterior walls
- removal of some internal walls
- replacement of the flooring
- replacement of the kitchen.
If the renovations are substantial, the property is treated as new residential premises.
Apart from the cost of replacing depreciating assets, the cost of all renovations are deductible as capital works.
The cost of replacing depreciating assets as part of substantial renovations, can be claimed as a decline in value deduction, provided the asset has been acquired as a new asset for the purpose of gaining income from rental income.
Example: claiming the cost of renovations
Jake bought a 4 bedroom residential property in October 2024 with the intent of it being a rental property. Three months before selling, the previous owners removed a wall between 2 bedrooms and turned the space into a large bedroom with an ensuite. They also repainted and recarpeted the room.
Even though Jake acquired the property within 6 months of the renovations being completed, the renovations only affected a part of the house, and aren't classified as being substantial renovations.
The previous owners provide Jake with the renovation construction costs.
The cost of the renovations, excluding the new carpet and any other depreciating assets replaced, can be claimed as a capital works deduction by Jake.
As the new carpet and other depreciating assets are not acquired as new assets by Jake, he can't claim a deduction for their decline in value.
However, if Jake buys any brand-new depreciating assets for the property, he will be able to claim a deduction for their decline in value.
End of example