Building a granny-flat in your backyard for your aging parents or for your older children might be an option that will work for your family, however when planning a granny-flat, it’s beneficial to know the tax and Capital Gains Tax (CGT) implications that might impact your property.
A granny-flat is a small, self-contained home that is built on your property that is separate to your main house. If the flat is built on your property, the area comes intact with its own bathroom, kitchen, lounge room and laundry. A granny-flat has a separate entrance, but not a separate title and are built within the boundary of your property. A granny-flat can’t be sold as a separate entity, unless the property is subdivided under a separate title.
Although granny-flats are usually built for aging parents, or for older children, others are built with the intention of generating rent. In this instance, the rent you receive is assessable income and you’ll be obligated to pay tax at your marginal tax rate. Normal tax deductions do apply, which may offer significant advantages.
There are advantages to building a granny-flat with the purpose of charging rent. The rental could provide much needed cash flow. Many people prefer to live in granny-flats, from students to people wanting to downsize and pay less rent themselves.
Building a granny-flat is usually cheaper than buying an investment property and can still offer tax deduction and negative gearing options.
Adding a granny-flat could increase the value of your home as it gives a new owner rental options, or ability to look after their older children or aging parents themselves. It’s also appealing to people looking for the benefits of an extra bedroom or separate space to use for a home office.
Pro Tax Tip: If your costs are more than your rent for a granny-flat, you can claim the loan interest, maintenance and insurance as tax deductions.
Capital Gains Tax
When you add on property for income, this becomes an investment and might trigger a CGT event when you sell your home. If you run a business from home and have a separate room or space to conduct your business, normally you may incur CGT. A granny-flat is no different as rent is considered an income stream. If you charge rent, you’ll lose some of your main residence exemption from CGT. Subdividing a granny-flat may also incur CGT.
Pro Tax Tip: Rent received from a family member living in the granny-flat is not considered commercial rent as the arrangement is deemed private or domestic.
Changes were made to granny-flat rental arrangements in the 2020 budget where a formal written agreement is in place enabling a CGT exemption that allows an eligible person the right to occupy property. For the agreement to be exempt from CGT, the person with the granny-flat interest must either be of pension age, or require assistance for day-to-day activities because of a disability. From 1 July 2021, CGT does not apply if a granny-flat arrangement is created, varied or terminated.
The CGT amount you might incur is determined based on your property’s sale profit and portion of land it occupies as generating income. CGT applies to a portion of the profit made. CGT will only apply to the years in which it generated income.
Pro Tax Tip: If you have a granny-flat and you can demonstrate that it was not used to generate income, the CGT exemption rule applies.
At the end of the financial year, your employer (or employers if you have more than one job) will finalise your income statement so
In many cases, granny-flats are built on children’s property after the sale of the aging parent’s home. The aging parent will pay cash to their child for the construction of their granny-flat and live there exclusively for life. Make sure you have a written agreement between both parties so that any government payments that the aging parent receives are unaffected and the older parent is legally protected.
Be aware that the cash payment given to the child carries CGT liability and will need to be paid by the child when they sell their home. The 50% discount on CGT for the disposal of an asset held over 12 months may not be available.
To be exempt from CGT, the granny-flat arrangement must be in writing, must indicate that both parties are legally bound and must not be commercial in nature. The agreement should include both parties with ownership interest in the property, the circumstances in which the arrangement can be varied or terminated and what happens when the arrangement is terminated.
Pro Tax Tip: Agreements can be varied when something happens not included in the original agreement. Both parties are eligible to add in new terms and agreements, and can also terminate and create a new agreement at any time.
If you’re considering building a granny-flat or purchasing a property with a granny-flat for private or commercial reason, its best to seek the advice of a tax professional who can help you navigate tax and CGT implication and reduce the overall tax you might be obligated to pay. Phone 1800 367 487 and chat with a professional today.