The new rules seek to ensure that CGT is not an impediment to formalising granny flat interests, with the aim of reducing the risk of financial abuse and exploitation of older Australians and other vulnerable people.
Background
A granny flat interest for social security purposes means an interest in another person’s private residence that involves acquiring (for consideration) or retaining:
· A right to accommodation for life in the residence, or
· A life interest in the residence.
With both kinds the person must be living there.
However the CGT implications of establishing, varying and terminating a granny flat interest have long been complex and uncertain.
For granny flat interests that involve a right to accommodation for life, Tax Ruling TR 2006/14 indicates that CGT event D1 (Creating contractual or other rights) may occur on the creation of the lifetime right to reside in the family member’s dwelling. The ruling indicates that a lifetime right to reside is usually formal and documented in writing, and this factor is considered when determining whether a CGT event has occurred.
However, granny flat arrangements do not have to be covered by a written agreement to be considered a ‘granny flat interest’ for social security purposes.
Among other reasons, the real and/or perceived CGT implications of entering into a formal grant flat arrangement may have contributed to a preference for informal arrangements, where it may be easier to argue that the arrangement is informal and no CGT applies. However, the informality of an agreement can make it difficult for the holder of the granny flat interest to establish, assert or enforce their rights, and lack provision for contingencies where circumstances change in the future.
Following analysis by both the Australian Law Reform Commission and the Board of Taxation, the Government has amended the CGT rules to encourage the formalisation of granny flat arrangements by providing a targeted CGT exemption for CGT events that would otherwise happen to granny flat interests, provided that certain requirements are met.
The new CGT exemption
From 1 July 2021, a CGT event (which would have otherwise happened) will not happen upon the creation, variation or termination of a granny flat interest provided the following requirements are met.
For this exemption, a granny flat interest is defined as a right to occupy a dwelling for life conferred by an arrangement.
Entering into an arrangement to create a granny flat interest· Both the person and the other individual are parties to the arrangement.
A CGT event that would otherwise occur on the creation of a granny flat interest in a dwelling under an arrangement does not happen if all of the following apply (at the time of entering into the arrangement):
- The person who holds the granny flat interest:
* Has reached pension age, or
* Because of a disability, needs assistance to carry out most day?to?day activities for at least the next 12 months.
- Another individual holds an ownership interest in the dwelling or agrees to acquire an ownership interest in the dwelling under the arrangement
- Both the person and the other individual are parties to the arrangement
- The arrangement is in writing and indicates an intention for the parties to be legally bound by it.
- The arrangement is not of a commercial nature.
Example 1: Creating granny flat interest
On 1 January 2022, Fred (age pension age) transfers the title of his home to his daughter Fiona in return for a right to reside there for life (granny flat interest). Fiona also moves into the home. Fred and Fiona enter into a legally binding written arrangement, which is not of a commercial nature.
As Fred and Fiona satisfy the requirements for the new CGT exemption at the time of entering into the arrangement, no CGT event arises for Fiona (or Fred) due to the creation of Fred’s granny flat interest.
Importantly, the exemption doesn’t apply to any other resulting CGT consequences of the transaction. This means that the exemption does not apply to the CGT event that arises when Fred disposes of his home to Fiona (see FAQ 4 for further information). However, Fred may instead qualify for the main residence exemption in relation to CGT event resulting from disposing of his main residence.
Varying a granny flat interest
The same conditions that apply above to exempt a CGT event from applying when entering into an agreement to establish a granny flat interest also apply to prevent a CGT event from happening where an existing arrangement is varied to vary (or create) a granny flat interest. However:
· The requirements must instead be met at the time the arrangement is varied, and
· The arrangement, as varied, must meet the requirements.
Example 2: Varying an arrangement to create a granny flat interest
In 2018, Audrey (age pension age) paid $300,000 to her daughter Gabby in return for a right to reside in Gabby’s home for life (granny flat interest), however it was an informal arrangement that was not in writing.
Audrey and Gabby now wish to formalise their agreement and on 1 January 2022, they enter into a written arrangement, which is not of a commercial nature.
As Audrey and Gabby satisfy the requirements for the new CGT exemption at the time of varying their arrangement, no CGT event arises for Gabby (or Audrey) due to the creation of Audrey’s granny flat interest.
Example 3: Varying an arrangement to vary a granny flat interest
Following on from example 1 (Fred and Fiona), in July 2022, Fiona decides to sell the home that Fred had transferred to her and, along with Fred, move into another home.
Fred and Fiona vary the arrangement for Fred’s granny flat interest so that Fred instead has a lifetime right to reside in Fiona’s new home. The varied arrangement is also not of a commercial nature.
As Fred and Fiona satisfy the requirements for the new CGT exemption at the time of varying the arrangement, no CGT event arises for Fiona (or Fred) due to the varying of Fred’s granny flat interest.
Terminating a granny flat interest
A CGT event that would otherwise occur on the termination of an arrangement (ceasing a granny flat interest) in a dwelling, does not happen if:
- A CGT event did not happen on entering into the arrangement to establish the granny flat interest (as it met the above requirements), or
- A CGT event did not happen on varying the arrangement to vary (or establish) the granny flat interest (as it met the above requirements).
Example 4: Ceasing a granny flat interest
On 1 January 2022, Allan (age pension age) pays $200,000 to his son Raymond in return for a right to reside in Raymond’s home for life (granny flat interest). Allan and Raymond enter into a legally binding written arrangement, which is not of a commercial nature.
As Allan and Raymond satisfy the requirements for the new CGT exemption at the time of entering into the arrangement, no CGT event arises for Raymond (or Allan) due to the creation of Allan’s granny flat interest.
On 1 January 2025, Allan enters residential aged care. At that time, Allan and Raymond terminate the existing arrangement and Allan’s granny flat interest ceases. As a CGT event did not happen on entering into the arrangement in January 2022 (as all requirements were met for the exemption), no CGT event arises for Allan (or Raymond) on the termination of the arrangement and cessation of the granny flat interest.
Frequently asked questions
1. What is the CGT impact on granny flat interests established prior to 1 July 2021?
Any CGT event that occurred prior to 1 July 2021 in respect of a granny flat interest is not impacted by this new exemption.
For example, where a formal arrangement to establish a granny flat interest was put in place in January 2020, ATO Tax Ruling TR 2006/14 provides that CGT event D1 may occur at that time. The introduction of the new exemption does nothing to change any capital gain that arose in January 2020.
An informal arrangement put in place prior to 1 July 2021 may reduce the risk of a CGT event having occurred at that time, however, tax advice should be sought to confirm this is the case.
Where an existing ‘pre-1 July 2021’ arrangement is varied, no further CGT event will occur at the time of the variation provided the requirements of the new exemption are satisfied at that time. This allows, for example, existing informal arrangements to be formalised (varied) on or after 1 July 2021 without a further CGT event occurring.
Where an existing ‘pre-1 July 2021’ arrangement is terminated on or after 1 July 2021, the new exemption only prevents any CGT event on termination from occurring where the arrangement had been varied on or after 1 July 2021. Whether a CGT event occurs on termination may also depend on whether the arrangement is an informal or formal arrangement. Note that where a CGT event does occur on termination (for example the new exemption is not satisfied), the person disposing of the granny flat interest may qualify for the CGT main residence exemption.
2. Does an arrangement to establish a granny flat interest need to take a particular form?
While required to be in writing to access the CGT exemption, there is no requirement that an arrangement establishing or varying a granny flat interest take a particular form.
This approach allows flexibility to ensure arrangements can have terms that best suit a person’s circumstances and avoid unnecessary requirements that might provide barriers to such arrangements.
However, the explanatory memorandum introducing the exemption indicates that any arrangement would at least deal with basic matters such as who the parties to the arrangement are, the circumstances in which the arrangement could be varied or terminated, and what happens on variation or termination.
People should seek legal advice when entering into or varying an arrangement to ensure that it meets their needs and that appropriate protections / contingencies are provided for.
3. How does a person tell whether the arrangement to establish their granny flat interest is ‘of a commercial nature’?
The explanatory memorandum introducing the exemption indicates that this would need to be established on a case by case basis and could take into account the level of any ongoing payments, as well as the amount and method of calculation of any consideration for the granny flat interest.
An example from the explanatory memorandum shows that where a person with a granny flat interest pays a monthly amount which is simply a contribution to the costs associated with running the household (rather than commercial rent), this is unlikely to be considered commercial in nature.
In contrast, an arrangement requiring a person holding a granny flat interest to pay rent at market rate could be an indicator that the arrangement may be commercial in nature.
4. Are other related CGT events impacted or exempted?
No. The new exemption only applies to the extent that the CGT event that would otherwise have happened relates to the creation, variation or termination of a granny flat interest.
Other CGT events that may occur as part of the broader process will still occur, and a capital gain may be assessable unless another type of exemption applies. Examples of capital gains that may occur include:
- A capital gain where assets (eg shares) are sold by a person in order to have proceeds to pay another person to establish a granny flat interest
- A capital gain where title of a property is transferred from the person’s name to another person’s name as consideration to establish a granny flat interest – where the property was the person’s main residence, a full or partial CGT main residence exemption may apply.
5. Does a granny flat interest impact the main residence exemption?
The explanatory memorandum introducing the exemption indicates that the existence of a granny flat interest in relation to a property should not have an impact on the application of the main residence exemption for the property owner.
6. Do these exemptions apply to granny flat interests that are a life interest (instead of simply a right occupy a dwelling for life)?
Unfortunately, it is unclear whether the new CGT exemption applies to a granny flat interest that constitutes a life interest. While a life interest practically does provide the holder with a right to occupy a dwelling for life, it goes further and allows the holder entitlement to any income from the property during their life. People who have a granny flat interest that is a life interest, or who are considering establishing such an interest, should seek legal advice to confirm whether their interest will qualify for the new CGT exemption.
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