The concept of living in a granny flat close to family is attractive, but it doesn’t always work out as a happy arrangement. By far the most effective way to protect the interests of both parent and child is to make sure the terms of the agreement are in writing.
Certainly, Centrelink encourages any granny flat interest arrangement to be put in writing.
However, until July 1, this year, capital gains tax meant that many people chose not to put their granny flat agreement in writing.
This created real difficulty in sorting things out when things did not work as planned.
Capital gains tax did not arise in every circumstance, but prior to 1 July it could arise in the following very common scenario.
A parent has $200,000 to build a flat on the child’s land. The payment is made, either to the child or a builder, who builds the flat, or extends the house. The parent gets a granny flat interest.
The land does (and must for Centrelink) stay in the child’s name. However, the child has received a gain, either in cash or increase in value, of the property, which is no longer solely their principal place of residence.
The ATO then says the child has received a $200,000 capital gain, which has crystallised, and tax must be paid on that amount.
Effectively two arms of government were driving people in opposite directions. Centrelink says – put it in writing. The tax department says if there’s an agreement like this the gain is taxable.
Accordingly, many families decided to do things informally and not confuse the tax department with paperwork, hoping the gain triggered would fly under the radar.
We have previously written about the risks of not having anything in writing in a granny flat arrangement (the full article is on our website), but in summary often events – health problems, separation, bankruptcy, financial difficulty, relocation for work etc – overtake the well-meaning initial intentions.
People often consult us about a granny flat arrangement that has fallen apart, sometimes simply because the parent and child don’t get on anymore, and the first question we ask is – is there an agreement in writing?
Usually, the answer is no.
Then we ask what were the terms of the agreement? Answer: Don’t know, I was going to live there until I died.
What was the plan if the parent got sick? Answer: Don’t know.
What if the child separated? Answer: Not discussed.
The child went bankrupt? Answer: Never thought of that.
With the new tax ruling from July 1, a granny flat agreement of this nature does not trigger capital gains tax, so there is no good reason not to have a written agreement and many good reasons to ensure it is in place.