Assisting clients with granny flat arrangements

By Janet Manzanero-Caruana, Senior Technical Services Manager

A new capital gains tax (CGT) exemption for the creation, variation or termination of a granny flat interest removes a barrier for older clients to enter formal granny flat arrangements. Formal or written arrangements offer older and vulnerable clients protection from financial abuse if circumstances change.

The new CGT exemption has passed both Houses and received royal assent. This new legislation will take effect from 1 July 2021.

A granny flat interest refers to arrangements where a significant amount of money and/or assets is given in exchange for a right to occupy a dwelling for life. The dwelling can be a self-contained dwelling located on someone else’s property, however there are other types of accommodation which can meet the definition for tax or social security purposes. Granny flat arrangements offer an alternative housing option to retirement villages, lifestyle parks or residential aged care which may provide older clients some assistance or personal care.

New CGT exemption

The new CGT exemption (which provides that no CGT event happens) applies to the creation, variation, and termination of a ‘granny flat interest’ if:

  • An eligible individual (older person) is granted a granny flat interest by the grantor
  • The grantor of the right owns the dwelling or agrees to acquire the dwelling in which the granny flat interest is or will be held
  • The older person and the grantor of the right must be parties to the arrangement
  • The arrangement is in writing and indicates the intention of both parties to be legally bound by it
  • The arrangement is not of a commercial nature.

For the CGT exemption to apply to a granny flat interest upon termination or surrender, the CGT exemption had needed to be applied when the granny flat interest was created or varied (from 1 July 2021).

Social security

Money or assets (or a combination of both) given for a granny flat interest may fall outside social security ‘gifting’ rules where certain conditions are met and may help clients retain or improve their age pension entitlements. The amount a client pays can also determine whether a client is treated as a homeowner or non-homeowner.

Centrelink recognises both formal and informal or undocumented granny flat arrangements.

Tax

In the past, many families may have opted for informal granny flat arrangements to save time, expense and to avoid potentially significant tax consequences for the person granting the right (‘grantor’).

Currently a capital gains tax (CGT) liability arises from granting the right to occupy (CGT even D1) or its cancellation or surrender (CGT event C2). The 50% CGT discount is generally not available for the grantor and the assessable capital gain can be significant as it is calculated as the consideration paid, less incidental costs such as legal and valuation fees.

Older clients who enter informal granny flat arrangements are at risk of losing a significant portion of their capital and their home, if circumstances change and there is no formal arrangement which protects their interests.

Right to occupy

A granny flat interest requires that the older person be granted a lifetime right to occupy a dwelling. A dwelling could be accommodation in the grantor’s family home, investment property or holiday home. A ‘right to occupy’ is distinguished from a life interest. A right to occupy provides the person with a right to live or reside in the property. A life interest may provide broader rights, for example, a right to 'use and occupy' a property, which may include rights to rents and profits from that property if the property was rented out. For social security purposes a granny flat interest may include a right to accommodation for life in the residence or a life interest in the residence.

The older person who holds the granny flat interest

The older person who holds the granny flat interest is eligible if they are, either:

  • Age pension age or older; or
  • have an on-going disability and is likely to require help with their daily activities for at least the next 12 months. Permanently disability or eligibility for the disability support pension is not required.

Grantor of the granny flat interest owns the dwelling or agrees to acquire the dwelling

The grantor of the right must own the dwelling (or agree to acquire the dwelling) in which the older person has or will be granted a right to occupy for life. The grantor of the right may be any person though it is often a family member.

The arrangement is required to be in writing and indicates an intention for the parties to be legally bound

Formal, written arrangements are usually drafted by a lawyer. There is no prescribed form of arrangement to allow the parties the flexibility to enter arrangements which suit their circumstances.

While no specific terms are required for the arrangement it should at least include:

  • who are parties to the agreement
  • the circumstances in which the arrangement can be varied or terminated
  • what happens when the arrangement is varied or terminated.

The arrangement is not of a commercial nature

The determination of whether an arrangement is not of a commercial nature depends on specific terms and circumstances of each arrangement. Charging rent at market rate may indicate the arrangement is of a commercial nature whereas contributions to the costs of household expenses may suggest the arrangement is not of a commercial nature. How the amount given for the granny flat interest is determined may also be a relevant factor.

Important considerations

If your client is the older person, it is important to prioritise their interests when dealing with a relative who may be the grantor of the right to occupy and hold Power of Attorney    as there can be a conflict of interests. You should carefully assess what your client is giving and what they will get in return.

As the client may be giving a substantial amount of their wealth, it is important they are protected if circumstances arise which require the arrangement to be varied or terminated.

Often your client will enter an arrangement with one family member which could have adverse implications for other family members. Open discussions with all the parties and family members who are likely to be affected can assist your client to arrive at appropriate terms with the grantor. This can require assistance from their lawyer.

A clearly written arrangement that covers the obligations and rights of the parties involved can prevent ambiguity and future conflict. Some potential issues and points of discussion could include:

  • How much will your client pay for the right to occupy?
  • What care will be provided, who will provide it and how regularly? Will part of the payment be for the care and support provided to the older person? If so, how will this be calculated?
  • What certain care or support will not be provided? E.g. transport arrangements for the older person for medical appointments or if they wish to go out?
  • How will the granny flat interest affect the inheritance of other family members? How can this be addressed to avoid discord in the future?
  • Are there arrangements for respite care or if the carers go on holidays?
  • What are the living arrangements? Will the older person share space with a family member? e.g. room in the family home or self-contained accommodation? Can the older person invite people to visit whenever they choose? Are pets allowed?
  • What household chores will each party be responsible for or share? For example, cooking meals and babysitting?
  • Will expenses such as food and utilities be shared? If yes, what proportion should be paid by the older person?
  • What happens if the older person needs a higher level of care which cannot be provided by the family? Who will pay the fees if the older person needs to move to residential aged care?
  • What happens if the parties terminate the arrangement voluntarily?
  • What if termination is involuntary? It’s important to consider unforeseen events such as:
    • the carer separates or divorces from their partner and moves from the residence
    • the carer becomes bankrupt
    • the older person’s relationship with the carer or their partner breaks down
    • the older person remarries and decides to move into their new partner’s home
    • the property is sold
    • a party moves interstate or overseas
    • a party dies or becomes ill
  • Can the older person recover some of the payment at termination? How will the amount be calculated and when will it be payable?
  • How disputes will be dealt with (e.g. by appointed mediator, tribunal, or as a last resort the courts)?
  • Should the arrangement be reviewed and varied where needed?

If possible, circumstances are considered, agreed on and included or annexed to the formal agreement, the parties can be provided with more certainty and clarity on how the arrangement will work in practice.

Tech Tip: While advisers often deal with a client’s family member who is their client’s Power of Attorney, it is important to remember that the client’s interests must always take priority.

Other matters

Consider inequalities in bargaining positions or any conflict of interests that may lead to unfair outcomes for your client. The capacity of an older client to enter a legally binding arrangement may also be a consideration. It is important that the parties understand the terms of the agreement and that it is legally binding, so independent legal advice is needed. A lawyer can prepare the written agreement which must be signed and witnessed.

Example

Ivy is an 80 year old widow. She has 3 children and lives independently in her home (worth $750,000). She has minimal assets and receives the full age pension. She is frail and has an approved level 1 ACAT assessment, determining that Ivy needs basic care needs.

Her family considers the following housing options:

  • Move to residential aged care
  • Stay in her home and receive services via a Home Care Package
  • Move into a retirement village and receive services via a Home Care Package
  • Or live with one of her children

Ivy’s daughter, Maud, and her partner, suggest they can provide on-going care for Ivy at their home if Ivy sells her home and provides $400,000 to build a self-contained extension to Maud’s property where Ivy could live. Ivy prefers this to moving to a retirement village or continuing to live alone. However, Maud’s other siblings raise concerns that most of their inheritance would go to building the dwelling, so would default to Maud having the bulk of the benefit. Ivy seeks advice from her financial adviser.

The financial adviser explains the impact the granny flat arrangement will have on Ivy’s age pension entitlements and that deprivation (gifting) rules may apply to the $400,000 payment if she ends the arrangement within five years. The adviser suggests she considers a formal granny flat arrangement to protect her interests and to meet with family to discuss their concerns, the risks, including any arrangements if the proposed arrangement does not work out for any reason, or if Ivy’s health deteriorates further and Maud cannot provide the care she needs (see ‘Important considerations’ outlined above).

The family discusses and agrees on Ivy’s living arrangements and the care Maud and her partner are to provide Ivy. If Ivy moves out of Maud’s home in the next 10 years for any reason, she will receive a refund. The amount of refund will reduce over time calculated using an agreed formula to account for the period Ivy lived with Maud and the care provided to her.

Maud and her partner will ensure Ivy moves to a suitable home (e.g. another dwelling or residential aged care) should this be a requirement. Any refund may be used for the new accommodation or fund her residential aged care fees.

If Ivy passes away, any refund will be paid to her estate and left equally to her children. The arrangement will be reviewed anytime if either or both parties request it.

The family seeks legal advice on how to structure and document the arrangement. Each party obtains independent legal advice before signing the agreement. Ivy’s will and powers of attorney are updated to reflect the arrangement.

Conclusion

The new CGT exemption for granny flat arrangements offers protection for older clients because it details the obligations parties to the agreement and is legally binding.

The agreement must address the older client’s wishes, which can be difficult to establish where the client has lost capacity. Raising awareness with retired clients to consider their living arrangements as they age can assist to prepare them for their future care and housing needs in advance.

Your clients will have to consider how to fund these arrangements, the impacts on any age pension and the inheritance they may wish to leave their children.


More information

If you have any questions, or would like more information, please contact the IOOF TechConnect team on 1300 650 414.

Disclaimer
The information in this section of the website is intended for financial advisers only and is not to be distributed to clients. It has been prepared on behalf of Australian Executor Trustees Limited ABN 84 007 869 794 AFSL 240023, IOOF Investment Management Limited ABN 53 006 695 021 AFSL 230524, IOOF Investment Services Ltd ABN 80 007 350 405, AFSL 230703 and IOOF Ltd ABN 21 087 649 625 AFSL 230522 based on information that is believed to be accurate and reliable at the time of publication.