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Australian Budget 2020 – Granny Flats and Capital Gains Tax

18 November 2020

Heartland Bank News

2020 Australian Government Budget Proposal

The Budget announcement last month revealed the Australian Government are preparing to pass a legislation, as early as 1 July 2021, to provide a targeted Capital Gains Tax (CGT) exemption for all formal granny flat arrangements where there is a formal written agreement between family members, to provide accommodation for older Australians or people with disabilities.

Currently there are around 3.9 million seniors and around 4 million Australians with a disability who, under this change, would be eligible for this exemption.

This will assist in providing a solution to older Australians who cannot live at home without help, and are unable to find, or do not want, a residential aged care place in a nursing home or an aged care facility.

Currently when a granny flat is constructed, many families enter informal arrangements, mostly to avoid tax implications, leaving some seniors vulnerable in the event of inadequate care, and bearing the risk of the main residence being sold due to foreclosure, bankruptcy, or relationship breakdown.

Formal Arrangements for granny flats

A formal granny flat arrangement requires families to enter into a legal contract. An important consideration with granting a legal right to occupy is the CGT impact on the grantor.

With a formal arrangement, the  individual residing in the flat may be required to make a payment of money or assets (such as, sale of their home) for the right to live in a granny flat constructed on the family member’s property. In some cases, the title of the senior’s home may also be transferred to the family member providing the right (grantor) and additional money may also be given.

A financial adviser would usually investigate the arrangement’s impact on the senior’s Centrelink or pension entitlements.

Important questions include:

  • Could a reverse mortgage be used rather than selling the home?
  • If the family member is over 60 who is providing the space for the granny flat, could they access a reverse mortgage to fund its construction?

What are the tax implications– When are they incurred?

Capital Gains Tax (CGT)

A CGT (event D1) happens when a grantor (family) has granted a legal right to occupancy to the grantee (senior)

  • A right of occupancy is a right to live in a property for life or for a certain term.
  • There are incidental costs associated to draw up a formal agreement relating to a granny flat and these may include fees paid to an accountant, valuer to determine market value of the flat and/or legal adviser for services relating to the granting of the right to live in it.
  • The grantor incurs a capital gain/loss if there was money paid or property given for the granny flat (excluding incidental costs mentioned, to draw up the agreement).
  • As the parties are family and not arms-length, the grantor is assumed to receive capital proceeds equal to the market value.
  • Market value is usually determined by a valuer and based on factors such as the location and type of accommodation, as well as the life expectancy of the person subject to the right (or the agreed term).
  • If the senior subsequently passes away, or disposes of the right to occupy the property, there are no CGT consequences, as the main residence exemption will apply and there will be no capital gain or loss incurred.

Case Study:

  • Ethel, aged 82, transfers her home valued at $700,000 to her daughter Rachel 62.
  • Rachel grants Ethel a lifetime right of occupancy in her home via a legal contract and agrees to take care of Ethel for as long as she lives.
  • Rachel then engages a builder and applies for a Heartland Reverse Mortgage with an initial advance, to build a granny flat for Ethel.
  • Rachel also engages the services of a valuer, accountant, and lawyer to formalise the agreement.
  • To fund the construction, Rachel takes out a reverse mortgage on the property, which Heartland approves (as Ethel’s right to occupy is via legal contract, rather than a financial interest listed on title). Ethel must be a nominated borrower, and will also receive Heartland’s lifetime occupancy promise.
  • The valuer determines the market value of the right of occupancy to be $250,000 and is paid a fee of $5,000.
  • The lawyer discusses the implications of the formal arrangement with Rachel, Ethel, and the family, and draws up a contract to evidence the granting of the right and formal agreement. He is paid a fee of $7,000.
  • The accountant advises on the tax consequences of granting of the right and is paid $3,000.
  • The Total Incidental costs of creating the granny flat right adds up to $15,000 (Valuer + Lawyer + Accountant). This excludes the cost for independent legal advice on the reverse mortgage.
  • As Rachel and Ethel are not dealing at arms-length, Rachel’s capital proceeds for granting the right is $250,000 even if the home is valued at $700,000.
  • Rachel’s assessable capital gain is $235,000 ($250,000 less $15,000 incidental costs).
  • The main residence exemption cannot reduce Rachel’s capital gain.
  • Ethel can claim the main residence exemption for the transfer of her home to her daughter Rachel.
  • If Ethel passes away, her right to occupancy terminates with no CGT implications and the Heartland Reverse Mortgage becomes due and payable from Ethel’s estate.

Summary

  • Rachel wants to help her mother and provide care by building a granny flat for Ethel to reside in.
  • As Rachels house and main residence, which is offered as security, is not altered or impacted, the purpose of the loan is deemed suitable as it is in the best interest of Ethel to live with her daughter and be cared for by a family member.
  • If the scenario evolves and Ethel requires round the clock specialised care, Rachel could also apply for further advance to pay for residential aged care fees such as the Refundable accommodation Deposit (RAD) or a Daily Payment Fee (DAP).

In conclusion, formal granny flat arrangements protect the interests of both parties. Informal arrangements do not offer as much protection for the grantee (seniors) and could result in challenges to their estate and keep them open to vulnerability and abuse. With new proposed changes to law, further protections can be granted without the complications of CGT, and a Heartland Reverse Mortgage could help fund its construction.

Information is accurate as of 30 October 2020 and may change from time to time.