The Australian Government has made important changes to how capital gains tax applies to granny flats.
These changes were outlined in legislation passed by the Australian Parliament in late June 2021 and came into effect on 1 July 2021.
Below is my take on the legislation, but as made clear in our disclaimer at the end, it’s vital that you get your own legal advice before entering into any transaction.
What’s the change in a nutshell?
Under Australian taxation law, family homes are generally exempt from capital gains tax.
However, up until 1 July 2021, there was the potential that you’d expose your family home to capital gains tax if you brought someone to live on your property as part of a signed granny flat arrangement.
The change provides a clear pathway forward to avoid this happening.
What is a granny flat arrangement?
A granny flat arrangement is an agreement between parties which supports someone having a granny flat interest.
A granny flat interest, in turn, is where somebody has a right to accommodation for life, or a specified lifetime ownership interest, in a property which is to be their main home.
The terms granny flat arrangement and interest are specifically outlined in Australian social security law.
Does the change only apply to granny flats?
No. While the change is likely to most commonly apply to the situation where a family member is living in a backyard granny flat, it could also apply to other living arrangements.
This could be where the family member simply lives in one of the bedrooms in the home or a self-contained flat attached to the main property.
As outlined in an Australian Board of Taxation review of granny flat arrangements: “A granny flat arrangement is someone much broader than the real estate notion and indeed can be created in accommodation which is not a granny flat”.
Are there age limits on the legal change?
Yes, for capital gains tax to not apply to the granny flat arrangement, the person in receipt of the granny flat interest must be of pension age, or disabled.
Does the person have to be a family member?
No. The legislation simply specifies that the granny flat arrangement cannot be of a “commercial nature”, but doesn’t specify the type of person that can benefit from the arrangement, for capital gains tax to not apply.
An Australian Treasury explanatory memorandum which accompanied the legislation said “any party” - including but not limited to relatives, friends and members of the same cultural community - may be able to benefit from the changes.
Can the granny flat arrangement be verbal?
No, for capital gains tax to not apply, the granny flat arrangement must be in writing and indicates an intention for the parties to the arrangement to be legally bound by it.
Can this reform be used by property investors to avoid capital gains tax?
No. This national-level reform is not designed to help property investors, who rent out their granny flat for profit and would love nothing more than to rid themselves of capital gains tax.
Property investors are excluded by the legislation’s clause relating to “commercial” arrangements, which is referred to above.
So what exactly does “not of a commercial nature” mean?
This is a bit of an open-ended statement in the legislation, and as such you’d imagine it could be a source of court battles in years to come.
However, to be fair to the government, it has tried to explain this phrase in the explanatory memorandum accompanying the legislation.
The memorandum says: “The commerciality of an arrangement would need to be determined on a case by case basis, considering the terms of the arrangement and circumstances of each case.”
“An arrangement requiring the holder of the granny flat interest to pay rent at a market rate to occupy the accommodation could be an indicator that the arrangement is of a commercial nature.”
“On the other hand if the individual who holds the granny flat interest merely contributes to the costs of running the household that they are living in, this could be more in the nature of a reimbursement of household expenses and suggest that the arrangement is not of a commercial nature.”
“The amount of any consideration for the granny flat interest and how it is worked out could also be a factor in determining whether the granny flat arrangement is of a commercial nature.”
The explanatory memorandum then gives a case study, where a woman has a granny flat interest in part of a home owned by her brother. The woman contributes to household costs, not rent, and these costs are lower than what the woman would pay for rent in the open market. In this instance, the arrangement is deemed to not be commercial.
Why has the change been introduced?
The Australian Government became concerned several years ago that families were actively avoiding creating granny flat arrangements, because of concerns that the arrangement could trigger a capital gains tax event.
This in turn meant elderly family members were handing over property titles or funds to other family members, on the basis of verbal care and accommodation promises from adult children.
Later, the children would claim the verbal care and accommodation promise had never been made, kept the property title or money (including claiming it was a “gift”), and then kicked the elderly parent out on the street.
This was clearly a form of elder abuse, which the government wanted to stamp out.
The change also has the benefit of helping to bring families closer together, which is particularly important during these difficult COVID-19 times.
What does the change mean for pension payments?
The change doesn’t have a specific impact on the interaction between granny flat arrangements and pension payments.
It is still the case that selling the family home and using some (but not all) of the proceeds to secure a granny flat interest could result in a pension breaching the pension asset thresholds, and therefore losing access to some or all of the pension.
There are also separate provisions stopping people from deliberately over-valuing the granny flat to ensure the person keeps their asset levels down and therefore continues to be able to access the pension.
Do I need to sign a new granny flat arrangement to take advantage of the changes?
No, as long as all the other requirements for this legislation are covered.
The legislation makes clear that it applies in the circumstances when a potential capital gains tax event would apply after 1 July, not when the arrangement is signed.
Should you see a lawyer before signing a granny flat arrangement?
Yes, yes and yes (and yes again!).
Granny flat arrangements are complicated, and expert advice is required before making any decision in relation to them. Preferably, the lawyer should be an expert not just in capital gains tax and property titling but also potential impacts on pension payments.
Where can I find out more?
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About granny flat interests (Services Australia website)
Disclaimer
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