The tax impact of renting your granny flat
Investing in a granny flat on your Perth property is becoming an increasingly common tax strategy, offering significant tax benefits, including the granny flat tax exemption. However, it’s essential to understand the complete tax implications associated with investing in a Perth granny flat.
This comprehensive guide explores key tax considerations when looking at the Australian tax rules for granny flats, including the main residence exemption, negative gearing, land tax, Goods and Services Tax (GST), the 6-year rule, and stamp duty related to property subdivision.
Getting good tax advice from your Perth tax accountant is important to properly structure your property portfolio.
1. Main Residence Exemption and Capital Gains Tax (CGT):
The main residence exemption allows homeowners to sell their primary residence without incurring CGT. However, if you rent out a portion of your property, such as a granny flat, this exemption may be affected.
The Australian Taxation Office (ATO) considers this a partial income-producing use, meaning you may only be eligible for a partial exemption.
Example Scenario:
- Property Purchase Price (2025): $650,000
- Granny Flat Proportion: 15% of total property value
- Property Sale Price (2029): $900,000
CGT Calculation:
- Total Capital Gain:
- $900,000 (sale price) – $650,000 (purchase price) = $250,000
- Assessable Portion:
- 15% of $250,000 = $37,500
- CGT Discount:
- Holding the property for more than 12 months qualifies you for a 50% CGT discount.
- 50% of $37,500 = $18,750
Thus, $18,750 would be added to your assessable income in the year of sale.
The apportionment of the main residence is a complex issue that needs thought and consideration.
2. The Tax impact of Negative Gearing the granny flat:
Negative gearing occurs when the expenses associated with an income-producing property exceed the rental income, resulting in a net loss. This loss can be offset against other income, potentially reducing your overall taxable income.
Considerations for a Granny Flat:
- Construction Costs: Interest on loans taken to finance the construction of a granny flat is deductible.
- Operating Expenses: Costs such as maintenance, utilities, and insurance related to the granny flat are deductible.
If these expenses exceed the rental income, you may have a negatively geared investment, which can lead to potential tax benefits.
You can only enjoy a tax deduction for the negative gearing of costs related to the granny flat. So, if some of the costs incurred relate to all of the property (like council rates) you will have to apportion them so they only cover the portion that relates to the granny flat (so 15% in this case).
If the granny flat is rented to an associated person (like your parents) the arrangement must be genuine and commercial to be effective. That is, you must act with your parents on the same basis as if a stranger were living in the granny flat.
Proving it is commercial and real can be challenging. If the arrangement is typically “on paper” where your parent pays rent, but they do so in cash and you give the money back to them as a gift, this is likely not to be a commercial arrangement.
A separate lease agreement, market evidence of the rent payable, and evidence of rent being paid into a bank account would typically be the minimum expectations.
3. Land Tax:
In Western Australia, land tax is levied annually on property owners based on the total unimproved value of their land holdings. The inclusion of a granny flat can influence your land tax obligations.
Key Points:
- Principal Place of Residence Exemption: If the property is your primary residence, you may be eligible for a land tax exemption.
- Impact of Rental Income: Earning rental income from a granny flat might affect your eligibility for this exemption.
It’s advisable to consult with the Department of Finance – RevenueWA or a legal professional to understand how a granny flat may impact your land tax liability.
4. Goods and Services Tax (GST):
Generally, the rental of residential premises is input-taxed, meaning:
- No GST on Rent: You do not charge GST on the rental income from the granny flat.
- No GST Credits: You cannot claim GST credits for expenses related to the granny flat.
However, if you provide short-term accommodation (e.g., through platforms like Airbnb), different GST rules may apply, potentially requiring you to register for GST and charge it on rental income.
If you build a granny flat, subdivide the property, and then sell the back block to a third person, you may be subject to GST on the sale of the new residential property. This might enjoy the margin scheme to reduce your GST position.
5. ATO’s Position and Guidelines:
The ATO provides clear guidance on how the CGT main residence exemption applies when a dwelling is partly used to derive income. Taxpayers are expected to reasonably apportion their capital gain based on factors such as floor area, market values, and duration of rental activity.
- ATO ID 2001/747 and ATO Tax Ruling TR 1999/67 clearly outline how the CGT main residence exemption applies when a dwelling is partly used to derive income.
- The ATO expects taxpayers to reasonably apportion their capital gain based on factors such as floor area, market value, and the duration of the rental activity.
6. The 6-Year Rule:
The 6-year rule allows you to treat your property as your main residence for up to six years after moving out, if it’s rented during your absence. This can enable you to claim the full main residence exemption upon sale.
Important Consideration:
- This rule applies when you completely vacate the property. The 6-year rule allows homeowners to maintain their main residence CGT exemption for up to six years after moving out and renting the property. However, this only applies if the entire property is rented out.
- If the homeowner continues to live in the main house while renting the granny flat, the exemption is partially reduced based on the portion of the property used for rental income.
Therefore, as a general guideline, rentvesting does not typically work for a granny flat when you live at the property.
7. Stamp Duty on Property Subdivision:
If you decide to subdivide your property to create a separate title for the granny flat, transfer duty (formerly known as stamp duty) considerations arise.
Key Points:
- Transfer Duty Liability: Transfer duty is imposed on certain transactions over property, including transfers of real estate and certain business assets.
- Valuation: The duty is calculated based on the dutiable value of the property being transferred.
For detailed information and to calculate potential transfer duty, refer to the Government of Western Australia – Department of Finance resources or contact a lawyer.
8. CGT Exemption for Granny Flat Arrangements
A granny flat arrangement is a formal written agreement granting an individual the right to occupy a property for life.
From 1 July 2021, a capital gains tax (CGT) exemption applies when a granny flat arrangement is created, varied, or terminated.
Who qualifies for the CGT exemption on Granny Flat Arrangements?
A granny flat arrangement is exempt from CGT if all the following conditions are met:
- The property’s owner(s) are individuals.
- One or more individuals hold an eligible interest in the granny flat of the property.
- The owners and individuals with an interest in the granny flat enter into a written and binding arrangement that is not commercial in nature.
The exemption applies only to the creation, modification, or termination of a granny flat arrangement.
Other CGT events unrelated to the arrangement remain subject to standard CGT rules. For example, if a property previously used in a granny flat arrangement is later sold, normal CGT provisions apply.
Example: CGT Exemption Eligibility
Garry agrees with his daughter, Sandra for a granny flat.
Under the arrangement:
- Sandra agrees to build an attached dwelling on her property for Garry to live in.
- Garry contributes $500,000 towards construction, funded by the sale of investment shares on the ASX.
Understanding the capital gains tax implications of a granny flat arrangement
For Sandra:
- Normally, granting a right of occupancy would trigger CGT event D1 (creation of a right).
- However, under the CGT exemption, no CGT is incurred when the arrangement is created.
For Garry:
- The sale of ASX shares is not exempt from CGT.
- Even though the proceeds are used to fund the construction, the sale of shares is not sufficiently connected to the granny flat arrangement to qualify for the exemption.
What is a granny flat interest?
A granny flat interest grants an individual a lifetime right to occupy a property under a formal agreement.
This interest is not limited to a traditional granny flat—it can apply to:
- The owner’s main residence.
- A separate property owned by the individual or another party.
- A portion or the entirety of a property.
What is a Granny Flat Arrangement?
To qualify for the CGT exemption, a granny flat arrangement must:
- Be in writing.
- Clearly define the parties’ legal obligations.
- Be non-commercial.
The agreement should specify:
- The parties involved, including the property owner(s) and the individual with an interest in the granny flat.
- The conditions under which the arrangement may be varied or terminated.
- The outcome if the arrangement is altered or ends.
Conclusion:
Investing in a granny flat in Perth involves navigating various tax implications. Understanding how the main residence exemption, negative gearing, land tax, GST, the 6-year rule, and transfer duty apply to your situation is crucial. Consulting with a qualified tax professional like Westcourt can provide personalised guidance, ensuring compliance and optimising the financial benefits of your investment.
If you are looking at your property portfolio, a tax advisor like Westcourt is a natural choice. Our single tax focus on business-minded families, independence of advice, deep global network and award-winning technical expertise positions us uniquely in the market, so why not call us?
