Granny flats - a good idea but beware the baggage

In this extract from Avoiding the Ageing Parent Trap, author and lawyerBrian Herd tells why granny flats have become so popular and why it’s vital to understand the regulations relating to them.

Granny flats are springing up across Australian suburbs as property owners convert their backyards for more independent living space, additional rental income and generous tax deductions.

However, a threefold recent increase in granny flat arrangements in the past five years also creates the possibility of the decline in pension or rent assistance payments and the sale of the family home, once tax free, attracting capital gains tax.

About 75 per cent more people have been building their blocks of land as subdivision or granny flats in the past five years, according to government statistics. While the statistics show that increases occur alongside a general construction boom, granny flat approvals have surged with a nationwide growth of 10 per cent, and an expected further 2 per cent growth by next year.

Read more: Does living in a granny flat affect your pension?

There are a variety of reasons why Australians are choosing to build a granny flat on their block. In the inner-city suburbs of Brisbane, Sydney and Melbourne, there is a higher demand for single-occupant dwellers, whether they are retirees, ageing relatives in need of care, travellers, students and more.

For some, it is an opportunity to gain additional income to assist managing the high costs of living or even save for that long-awaited overseas trip. For others, it can be a great way to provide extra living space, an office or studio separate from the main house.

With the increasing cost of living, many young people are staying home with their parents and relatives longer than before, with rates of under 25-year-olds moving out falling by 20 per cent in the past five years. It is also common for ageing relatives to remain close and involved with their families while maintaining their own independent lives.

Read more: What is a granny flat interest ad how can it help you?

An ageing population, rising house prices and capitalising on existing land are all contributing factors to a rise in the popularity of granny flat arrangements. Undoubtedly the granny flat boom could clearly be considered an indicator of classic Australian entrepreneurship making the most out of their situation.

What is a granny flat arrangement?
A granny flat arrangement is similar to a family care agreement, but it is driven and controlled by Centrelink requirements and the need to preserve Age Pensions. The arrangement can be established when you exchange assets or money with someone else in return for the right to live on their property for life. Longevity means it has taken on an increasingly relevant lifestyle significance in later life.

The term has also reached the dizzying heights of a recognised legal term. The federal government first introduced the concept in changes to the Social Security Act in 1991, which are known, colloquially, as the ‘granny flat rules’.

Before examining those rules, I have another beef with the term, ‘granny flat arrangement’ -the use of the word ‘arrangement’. It probably represents our innate attempt to downplay the significance of it and to avoid the spectre of any legal implications. Let’s be frank, however, a granny flat arrangement is more than an arrangement, it is an agreement with all the legal implications that has. The granny flat rules have no effect on the non-age pensioner or self-funded retiree who may enter into this type of agreement. They will probably just enter a Family Care Agreement.

Read more: When granny flats go wrong

However, if a parent is on an Age Pension and is considering a living arrangement involving children or anyone else, it is vital to understand the Age Pension implications in doing so i.e., the granny flat rules. It all gets a bit contorted but here is an abbreviated explanation.

The necessity for the rules arises out of the impact of another social security rule – known as the ‘deprivation rule’ or the rule about gifting assets. Because qualification for an Age Pension is limited by the assets and incomes test, in the good old days, older people would often give away assets to qualify for the pension. The government got wind of this and introduced a law to address this ‘avoidance’ device. Put simply, the current rule is that if an age pensioner gives away assets or money of more than $10,000 in any year or an aggregate of $30,000 over five years (and up to five years before they qualified for a pension), anything above those limits will be regarded as still theirs for another five years, even though they may have given it away. It is a ‘Clayton’s’ gift in Centrelink’s eyes. You may have given something away but you still have it. The government, through Centrelink, wants to encourage them, for obvious reasons, in terms of limiting the increasing expenditure on subsidising aged care.

But, because the essence of a granny flat agreement is the gifting of assets or money, the government had to create an exception and hence the granny flat rules.

So, what is a granny flat agreement?

It usually involves an older person/s paying something or transferring an asset to someone in exchange for a right to live in a home for life. That home must be used as the person’s principal place of residence. They come in various shapes and sizes, and here are some examples:

  • parents sell their home and pay for a granny flat to be built in the daughter’s backyard.
  • A parent sells their home and pays their child for the right to simply move into a child’s home.
  • a parent transfers the title to their home to her son while retaining the right to live there.
  • a parent sells their home and uses the proceeds towards a new home for their daughter.

All in exchange for a right to live there for life. Any of these arrangements must satisfy certain criteria to qualify as a granny flat, namely:

  • a person pays for a life interest or right to accommodation for life.
  • that life interest or right to accommodation must be in a private residence that is to the person’s principal home.
  • the parties to the arrangement do not reasonably contemplate that it will come to an end within five years.

The amount of the payment is generally not relevant except if it exceeds what is known as the ‘reasonableness test’. In a nutshell and as an example, if a person transfers not only their home to someone else but additional assets, the test will be applied and it may be that the additional amount is not covered by the exemption and will be assessed as a gift.

Regrettably, another arm of government has cast a small uncertainty over them, in terms of potential CGT [capital gains tax] consequences for the adult child involved. There is some suggestion by the Australian Tax Office that certain types of granny flat agreements may activate some CGT obligations on a child involving, as some agreements do, the grant of a right to reside in the child’s home, which may be perceived as the creation of taxable right even though it relates to the child’s principal place of residence.

Fortunately, the government has discovered this double message imbroglio and has referred the tax issue to the Board of Taxation for review and recommendations. As a result of the Board of Taxations review and recommendations, it is pleasing to note that, in its 2020/2021 Budget, the Commonwealth government announced legislation would be introduced with effect from 1 July 2021 providing that a homeowner would no longer have to pay CGT for the creation, variation or termination of a formal written granny flat agreement providing accommodation of older Australians or people with disabilities.

The granny flat rules consist of a number of elements, which all need to be satisfied before an agreement will be accepted as compliant and not result in any change to the parent’s pension entitlements. Again, you are well advised to seek financial advice on the agreement, before it is signed. I also have the agreements I draft vetted by Centrelink before they are signed just to be sure, to be sure.

This is an extract from Avoiding the Ageing Parent Trap by Brian Herd, published by Big Sky Publishing, RRP $29.99

Do you live in granny flat? Or have you entered a granny flat arrangement? Were the regulations difficult to work through?

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