Granny flats- tax tips and traps

Granny flats: tax tips and traps

Granny flats- tax tips and traps

Granny flats: tax tips and traps

The idea of adding a granny flat to your property sounds like a great idea. A property to rent out to generate some welcome extra income, or a home for adult children or mum and dad in their later years.

But there are important tax and personal considerations to consider before taking the plunge and digging up the backyard. Although the Federal Budget proposed significant reform in this area (which we cover later in this article), important tax questions remain.

Tax and granny flats: what you need to know

A granny flat is usually a self-contained secondary dwelling with a separate entrance, bathroom, kitchen and living space.

Unlike an investment property, granny flats do not have a separate title and are built within the boundary of your existing property or attached to your home. A granny flat cannot be sold separately unless you subdivide the existing property title.

Before you rush off to start building, you need to carefully consider the tax implications and get professional advice, or you could find yourself facing significant tax bills.

For example, if you rent out your granny flat at commercial rates to a third party like a student, the rent will be assessable income and you will pay income tax on it at your marginal tax rate. You are, however, entitled to claim the normal deductions for depreciation against income from an investment property.i

Subdividing the property could also create a GST obligation, as the flat may be deemed a new residential property.

Granny flats and capital gains

Under current legislation, the main tax issue when adding a granny flat is that it can create a capital gains tax (CGT) headache when it comes time to sell your home. CGT is payable on the difference in value between the time you bought the property and the time you sell.

Normally, your main residence is exempt from CGT, but adding a granny flat can affect this. If you charge rent to a student living in your granny flat for example, you will lose some of your main residence exemption from CGT as the property is partly being used for income-producing purposes.

When a family member lives in a granny flat and does not pay commercial rent, generally the main residence exemption still applies as the arrangement is deemed private or domestic.

CGT and cash contributions

Things get more complicated if a relative provides a cash sum to help pay for the cost of building a granny flat in return for a right of occupancy for life or life interest.

Under current tax laws, a cash sum paid by one party to build a granny flat is a CGT event. This means if your parent makes a financial contribution towards you building a flat to live in on your property, you will have a partial CGT liability to pay when you eventually sell your home.

To make things worse, the normal 50 per cent discount on CGT for the disposal of an asset held for over 12 months may not be available.

Potential for elder abuse

In many cases, concern about paying CGT means families fail to put formal agreements in place when a relative contributes to the cost of a granny flat. This leaves the family member with no protection if the relationship breaks down and creates the potential for financial abuse.

The family member can also lose out financially if they need to move into an aged care facility, or if the homeowner needs to sell.

It’s also worth noting that an interest in a granny flat can affect social security entitlements and aged care fees.

Proposed Federal Budget exemption

To solve some of these issues, the October 2020 Federal Budget included a proposed CGT exemption for granny flats where a formal written agreement is in place. The new measure will be limited to arrangements covering family relationships and disabled children – not commercial rentals.

Eligibility conditions for the new CGT exemption will depend on the legislation eventually being passed by Parliament. If passed, a start date is expected as early as 1 July 2021.

If you are considering building a granny flat on your property, contact us today to discuss the potential tax implications.

This article is intended as an information source only and to provide general information only. The comments, examples, words and extracts from legislation and other sources in this publication do not constitute legal advice, financial or tax advice and should not be relied upon as such. All readers should seek advice from a professional adviser regarding the application of any of the comments in this article to their particular situation.

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You can claim borrowing expenses greater than $100 over a five year period or over the life of the loan whichever is the least. You can claim all of the following borrowing costs

• stamp duty charged on mortgage (note this is not the stamp duty on purchase of the property)
• loan establishment fees
• title search fees charged by the lender
• costs for preparing and filing the mortgage documents
• mortgage broker fees
• valuation fees for loan approval
• lender’s mortgage insurance

It is important in the first year that you don’t claim the full amount amortised over the five year period but you will need to apportion the first years borrowing costs over the number of days between the date you took out the loan and the end of that particular financial year. Another common mistake is either not claiming the borrowing costs at all or claiming them all in the first year the loan is taken out.

If a loan has been taken out and has a mix of private and investment/business components (something we recommend you really try to avoid and work together with your accountant and mortgage broker to prevent getting into this sticky situation) then the borrowing expenses also need apportioned.

Property Inheritance and Taxes

The passing away of someone you love is a tragic event but not taking into account the tax considerations on sale of any property you receive from an inheritance as part of that estate can cause further grief.

Main Residence

If the property was used as the main residence of the deceased then any capital gain or loss on a dwelling acquired by an individual as a beneficiary of deceased estate or by the trustee of a deceased estate will be fully exempt if

  1. the dwelling was the deceased’s main residence just before they died or it was the deceased’s pre-CGT property; and
  2. the dwelling was disposed of within two years of the deceased’s death, or it was, from the time of death until the disposal, the main residence of
  • the spouse of the deceased
  • an individual who had the right to occupy the dwelling under the will of the deceased ; or
  • a beneficiary

3. then need to consider a number of events with your adviser.

Careful planning needs to be undertaken to ensure that this event is planned for.

For all other property, other than your main residence or other dwelling e.g. an investment property, you will need to determine whether the property is a pre-CGT asset (purchased prior to 20 Sept 1985) or a post-CGT asset (purchased after 20 Sept 1985).

Pre CGT Assets of the Deceased

If the property you inherit was acquired by the deceased prior to 20 September 1985 you will be deemed to have acquired the property for its market value on the day the deceased died.  It will then be a post CGT asset for you.  You will need to hold the property for more than 12 months from the date the deceased died in order to obtain the 50% general CGT discount.

Remember though the special rules in Section 118-195 ITAA 1997.  If the property was acquired by the deceased prior to Sept 1985 and you dispose of that property within 2 years of the deceased date of death there will be no CGT on the sale of that property.  Many accountants do not read the table in Section 118-195 properly and think it is to be read like most tables.  However s118-195 makes it very clear only one condition in Column 3 and one condition in Column 2 is required.  It is a matrix not a table.  We have seen this to be a common mistake made by many accountants.

Post CGT Assets of the Deceased

If the property you inherit, other than your main residence (discussed above) or other dwelling e.g. an investment property which are subject to special rules (worth discussing with your adviser), was acquired by the deceased on or after 20 September 1985 you will be deemed to have acquired the property for the cost base and the reduced cost base that applied to the deceased.  You will need to hold the property for more than 12 months from the date the deceased acquired the property to obtain the 50% general CGT discount.

They say that two things in life are certain.  Death and taxes.  Unfortunately the two are often intertwined.  House of Wealth are able to assist with the preparation of a deceased clients tax return.