What's the problem?
At the moment, social security law and tax law clash when an elderly person seeks to live with a carer in a granny flat arrangement, with a documented agreement that provides security for the elderly person and sets out the rights and responsibilities of both parties.
What’s a granny flat?
A granny flat is a term that has been applied to an arrangement whereby an elderly person resides with another (referred to as the carer in this web page), either in their home, or in a separately constructed dwelling on their property.
The arrangement typically includes some form of assistance with daily activities, or the proximity to provide this assistance in the future as the elderly person’s health declines.
Most commonly the arrangement is made between an elderly parent, and one of their children (who may have a spouse and family of their own).
Some common reasons that an elderly person and their carer might consider a granny flat arrangement are:
Allowing an elderly person to remain in their current location, when they can no longer maintain the property alone
Allowing an elderly person to live close to a carer who is a family member, as an alternative to entering an aged care facility
Providing a means for the elderly person to access part of the capital tied up in a residential property, while still retaining a place to live
For companionship and care, after an elderly person has lost his or her partner to illness
Having a treasured family home remain in family ownership, even if no longer suitable for the elderly person
A granny flat agreement is also recognised under social security law as being similar to ownership of a property. Subject to certain limits, money given to a carer in return for a granny flat agreement is excluded from gifting provisions in social security law.
What are the reasons for entering a granny flat arrangement?
Often when the decision is made to put a granny flat arrangement in place it requires a change to the living arrangements of the elderly person, their carer, or both. This can look like:
Elderly person sells their home, provides a lump sum to a carer to construct self‑contained accommodation on their existing property
Elderly person and carer both sell their home, using capital to purchase suitable accommodation in the name of the carer
Elderly person transfers title in their existing property to carer, carer and family move into the property
What are the transactions involved?
When the elderly person owns their home, this ownership provides them with security of his or her interests. Under a granny flat agreement however, while the elderly person has contributed significant capital or property, legal title to the property usually resides with the carer. This means that the elderly person’s rights need to be otherwise secured, through the use of a contract, deed, or other legal document. The scenarios and rights to be covered can include:
What happens if the carer wishes to sell the property
What happens if the carer is made bankrupt
What happens if the carer and their partner separate and complete a property settlement
The elderly person’s rights to participate in any capital gain or loss if the property is sold
The circumstances in which either party can end the agreement, and the financial consequences of doing so
What are each party’s expectations of care services to be provided, in addition to the provision of a right to reside
s12A(2)(b)(i) Social Security Act 1991 which defines a granny flat interest for social security purposes also references “a right to accommodation for life,” so without a properly enforceable right to accommodation the arrangement may not qualify for the resulting social security concessions.
Why it’s important to properly document a granny flat agreement
When dealing with a main residence (a person’s home), any capital gains are disregarded under s118-110 Income Tax Assessment Act 1997. This section serves to disregards capital gains made under a number of capital gains events such as sale of the asset (CGT event A1), loss of an asset (CGT event C1), or creating a trust over an asset (CGT event E1).
Tax Ruling 2006/14 paragraph 105 however defines the creation of a right to reside (a granny flat arrangement) as creating contractual or other rights (CGT event D1). The main residence exemption does not apply to this transaction. This results in an immediate capital gain for the carer.
Joyce (79) wishes to move in with her son David (51) and daughter-in-law Sally (49) who own their own home in a nearby suburb. David and Sally both work, earning $50,000 in taxable income.
Their house is not big enough for Joyce to live in it with them, and she would like to retain some independence, so Joyce sells her house and provides $150,000 to David and Sally to construct a self-contained flat on their property. To avoid disputes and secure the rights of all parties, a solicitor is engaged to draw up an agreement for the granny flat arrangements.
David and Sally have subsequently made a capital gain of $75,000 each, less incidental costs such as the drafting of the agreement. Based on their marginal tax rates, they will have to pay $27,900 each in income tax and Medicare levies, $55,800 in total.
The current tax treatment of granny flat agreements
Currently, many people enter agreements without professional advice (often after having reviewed information about granny flat arrangements from Department of Human Services). Because the Australian tax system is based on self assessment, they are failing to report the gain.
Worryingly, many who do seek professional assistance, once having the tax implications for the carer explained, are choosing to forego protection of their interests through a documented agreement. This leaves the elderly person subject to a loss of their capital with no security of accommodation. Elder financial abuse is an area of concern but these losses may also arise where there is a change of circumstances on the part of the carer, such as needing to move for work or family reasons, or the breakdown of a relationship and a requirement to sell assets as part of a property settlement.
Numerous extensions to the main residence capital gains exemption exist in Income Tax Assessment Act 1997. The closest of these to a granny flat arrangement are those that allow for a capital gain to be disregarded when the property has been the main residence of a person with an equitable life interest in the property (under CGT event E1).
Amendments could be made to bring granny flat arrangements under CGT event E1, which benefits from existing main residence exemptions, or a new exemption could be created for granny flat arrangements.