Tax implications of granny flats

Building a granny flat could still be a smart financial move for property owners.

With an ageing population and a rise in property prices, granny flats are becoming increasingly popular amongst Australian home-owners.

Traditionally used to house relatives, but increasingly seen as an additional source of rental income, granny flats seem a smart step for the property owner looking to extend their Perth home (and income prospects) at a relatively low cost.

However, these backyard additions aren’t always as straightforward as they first seem.

Depending on how you plan to use them (and who is going to use them), granny flats can cause different tax implications when it comes time to sell.

Definition of capital gains tax

 According to the Australian Taxation Office, a capital gain (or loss) on a property is the difference in value between the time of investment and the time of sale.

Capital gains tax (as per the name) is the tax you pay on a capital gain. Personal assets such as the family home are usually exempt from this tax.

Owning a granny flat

Regardless of whether they are freestanding or attached to the primary residence, granny flats cannot have a separate ownership title. This means the owner of the main residence must also own the granny flat.

The price of the flat is then added to the price of the entire property, and the flat cannot be sold separately. Unless you have permission under the local planning scheme, the land occupied by the granny flat cannot be subdivided.

Depending on your local council or state, the size regulations and permits required to build a granny flat may also differ.

Is your property exempt from capital gains tax?

The family home is normally exempt from capital gains tax (CGT), but your granny flat (now classified as part of your overall property) may not be.

Whether your property is exempt or not ultimately depends on how you plan to use the flat. If you’re leasing it out to a relative, rental income may not – depending on the status of the relationship – be taxable under CGT as this would not be classified as a commercial transaction.

However, if you’re renting the flat out to a third party, this would be considered commercial rent, meaning your property could become partially liable to CGT in the event of a sale. In this case, you would also be entitled to tax deductions on the granny flat.

If you plan on renting the flat out for income-producing purposes, you should therefore keep a record of all deductible expenses (i.e. borrowing, maintenance and running costs).

How much of your property would be liable to CGT?

If you’re renting your granny flat out to a third party, it’s important to note not all your property would be liable to CGT in the event of a sale. Any capital gains made on the property since the time the granny flat was constructed would be subject to CGT.

However, this tax is calculated relative to the area of your property occupied by the flat. If the granny flat only occupies one fifth of your overall property, for example, only one fifth of the increase in value since construction of the flat would be subject to CGT.

This situation gets even more complicated if the granny flat is not used to generate rental income on a full-time basis. In this case, the property would only be subject to CGT for the portion of time it was used for income-producing purposes.

If you’ve held the property for over a year at the time of sale, you would also have access to the 50% discount on CGT.

This isn’t to say you shouldn’t invest

Despite their various tax implications, building a granny flat could still be a smart financial move for property owners. The key to a successful investment is to know your stuff and remain prepared when it comes to tax time and/or property sale.

Before constructing a granny flat, you should consult a financial advisor to ensure you fully understand the tax implications associated with this type of property arrangement.

If you plan on renting the property out for income-producing purposes, you should also keep a record of any expenses and construction costs that could be tax deductible.

Need help managing your properties?

Whether you’re an experienced property investor or a home-owner looking to start your investment portfolio, the specialised property management team at Rentwest can help you manage your investments after purchase.

As well as overseeing rental collection and the day-to-day management of your Perth properties, our team of experienced property managers can help you make the right decisions when it comes to increasing the value of your purchase property.

Get in touch with Rentwest team today via email at rentals@rentwest.com.au or call 08 9314 9888.

The information provided in this article is of a general nature only. Rentwest recommends consulting a qualified professional for advice best suited to individual needs.