It’s an idea which seems so simple - organise for your elderly parent to live in a newly-built granny flat in your backyard.
It means that the ageing parent is able to get ongoing care and support from his or her children and grandchildren.
At the same time, the grandkids get to enjoy baby-sitting support and lots of love and attention from the grandparent.
However, in seeking this laudable multi-generational outcome, it is possible to create a range of unwanted financial issues.
If not carefully planned, granny flats have the potential to create both capital gains tax and pension surprises, as outlined below.
About granny flat interests
When a granny flat is created and occupied, it is preferable that a legal document is created which defines the rights of each party involved in the arrangement.
Informally, this is known as a granny flat interest, and usually allows the parent to live in the property for life (known as a life tenancy), or to live in the property for life and rent it out if he or she is not living there (known as a life interest).
Capital gains tax
If such a legal arrangement is created however, it does have the potential to erase the family home’s status as tax-exempt, which would mean the family would need to pay capital gains tax.
This is particularly the case when the granny flat interest is created, but the child doesn’t at the same time off-load a portion of the property to his or her parent.
Potential for elder abuse
The problem is not just the potential tax burden, it is also the prospect that the children will deliberately avoid creating an agreement with their parent so they don’t have to pay tax and to avoid transferring property.
The Australian Government has recognised that this legal vaccum in turn creates a fertile environment for elder abuse.
A potential and extreme elder abuse scenario is when an older parent sells their property and pays their child to build a granny flat, but at the same time does not gain a legal right to occupy the property.
This means the parent may - after a period of time - be forced to vacate the premises and therefore end up homeless, while the unscrupulous children pocket the family home sales proceeds.
The government recognises there is currently a tax disincentive to sign granny flat interests - which at the same time can lead to elder abuse - and has therefore asked the Board of Taxation to undertake a review of the situation.
The review report has been sitting with the government since at least November last year, but at this stage it has not been released, nor has the government published its response.
We expect this government response should be happening shortly, and it potentially could have some very interesting policy and tax outcomes.
- IMPORTANT UPDATE: In the 2020-21 budget in October 2020, the Australian Government released the Board of Taxation report and announced it will be introducing legislation so that granny flat arrangements would be exempt from capital gains tax
Aged pension implications
Separately, a granny flat interest has the potential to impact on aged pension payments.
If a granny flat interest is worth more than $210,500, then under Australia’s social security laws the parent would be regarded as a homeowner and would therefore no longer be eligible for Commonwealth rental assistance.
By the same token, if the amount is less than $210,500, then the amount is counted towards the parent’s overall non-homeowner assets for the purposes of calculating their pension payments.
What’s more, the Australian Government has implemented a reasonableness test to stop families from grossly understating the value of the granny flat interest, so parents can continue to claim the same pension amount.
For something which seems so simple, granny flat arrangements are pretty complicated.
It’s essential to see an expert financial and/or legal advisor before starting your granny flat journey.
See also: Thinking about a granny flat?
Please note this story has been prepared as a general guide only, and should not be relied upon as a substitute for seeking your own independent legal and financial advice.
Any references or links to third party resources or websites are provided in good faith, but we take no responsibility for their content, and you must rely upon your own enquiries and seek professional advice before acting. See more detailed terms and conditions here.