David Shaw, WSC Group CEO and Founder, discusses the unexpected tax and accounting challenges with the burgeoning property investment area of granny flats. This type of development can not only be built within an investment property, but also in Principal Places of Residences, he writes. David recently presented on this topic at the Legalwise “Granny Flats: The Unseen Risks” seminar in NSW.
Property Investors looking at an alternative way to grow their portfolios are now investing in large blocks of land and building a Granny Flat at the back of their property. This development can not only be built within an investment property, but also in Principal Places of Residences (PPR’s).
However, before undertaking any Granny Flat development one must seek expert advice or run the risk of having unforeseen issues arise during tax time. Below are some of these issues:
1. Renting a Granny Flat: Are there Income Tax Benefits?
According to TR 92/3 and 92/4, Granny Flat rental income ‘profits’ and expenses ‘losses’ will be assessed and deductible at the marginal rates of tax. On the surface, one may assume for tax purposes that it is treated similarly as a normal investment property however, they must consider the following:
a. Rental expenses such as council and water rates must be claimed based on the land-area occupied by the Granny Flat, adding a reasonable amount based on access to common areas.
b. A Quantity Surveyors Report should be prepared after construction to claim depreciation of a Granny Flat each year and for an estimated total construction cost for cost base purposes.
c. Short-term Airbnb (compared to permanent rental) Granny Flats on average receive higher total rental income, larger before tax cash profit and an overall greater return. This is similarly the case for existing investment properties with a Granny Flat (compared to a stand-alone investment property).
d. Granny Flats where rental income received is less than market or commercial rates limit the deductions one can claim. As an example, Margie generously allowed her daughter who was made redundant to move into her Granny Flat, at non-commercial rents (below market rent). This resulted in before tax cash losses being considerably greater, however unfortunately deductions could only be claimed up to the value of the rental income received and nothing over. As such, there was no access to any tax benefits that generally were accessible to such negatively geared properties.
2. Granny Flats and PPR’s: Is the Sale CGT Exempt?
If a Granny Flat is built in the backyard of a PPR and then rented out, then there is only a partial CGT main residence exemption. In the event of a sale, the cost base will be made up of a share of the combined costs, the attributed land value and the construction costs of the Granny Flat.
On the other hand, where no rent has been charged for residing, such as in family arrangements or Granny Flats used as teenagers’ retreat, parents living quarters or storage units, there is no loss of CGT exemption.
3. Granny Flats and Possible GST Implications
Usually residential property sales are ‘input taxed’, meaning there is no GST to be included in the sale price with no access to claim GST on costs. However, sub-division may result in GST obligations – such as a mandatory ABN application, GST registration and Business Activity Statement preparation. The determining factor is if the development is considered an ‘Enterprise’ for GST purposes – if it has both:
a. A profit motive, and
b. Commercial characteristics
We were recently informed by a client that they built a Granny Flat on the back of their investment property, sub-divided it between the two dwellings and then sold both properties. We pointed out to the client that the construction of the Granny Flat constituted a new residential premise and therefore the client was liable for GST on the Granny Flat sale. The CGT discount would not be available because the properties were purchased and developed with the intention or purpose of making a profit. If this is you, you can claim a credit for the GST on the construction of the Granny Flat and sell the property under the margin scheme, as opposed to paying GST on the entire sale price of the dwelling to minimise the GST payable.
4. Granny Flats and Capital Gains Tax: Will the 50% CGT Discount Apply?
To receive the 50% CGT Discount on the sale of a Granny Flat, one must have owned the property for at least 12 months (even if the Granny Flat was not constructed for more than 12 months before the CGT event). Most importantly, if one wants to assure themselves of being able to obtain a CGT discount on the sale of the Granny Flat, they must:
a. Demonstrate their intention was to always build and hold the dwelling long term.
b. To be conservative, continuously rent out the Granny Flat for a period of 5 years. The dwelling will no longer be deemed as a new residential premise under GST regulations.
c. Be able to prove in the event of a tax audit that they do not run a business which constructs multiple Granny Flat developments.
5. Granny Flats and Changing Tax Treatments
As an indication of how one must keep up-to-date in this field, in early 2019 the Board of Taxation will undertake a review of the current tax treatment of common Granny Flat arrangements.
Under current tax law, CGT may apply where a family member resides in their Granny Flat, such as an older parent living with their child, if they are under a formal and legally enforceable family agreement. This deters some in establishing these agreements, leaving no protection for the rights of the elder parent if there is an unexpected breakdown. As such, the review will recommend incentives for the use of such agreements as a measure to prevent elder abuse. We’ll find more about this in the second half of 2019.
Where to start?
The above demonstrates the complexities of dealing with Granny Flat developments and the various tax consequences of not seeking the right advice upfront. It is imperative that these are considered well in advance before one has fallen for the ‘Hidden Tax and Accounting Issues’ mentioned above.
WSC Group focuses is on delivering remarkable value to clients across Australia. With over 25 years’ of business experience, David has been instrumental in developing a team culture built on excellence.
David has many years of accounting experience with extensive knowledge in commerce, industry and public practice accounting. During his accounting career, he has held senior accounting roles with Deloittes, Pacific Dunlop, Boral and National Foods. Prior to starting WSC Group, over 10 years ago, David was a Director and CEO of Pickles Auctions Group. Specialising in establishing financial systems and management controls, David offers his clients strategic planning and growth assistance. David has also developed an extensive property expertise from the property investor level to corporate property development of both new developments and second-hand property refurbishments.
David has a degree in Business (Accounting Major with the University of Technology Sydney), is a CPA with a Public Practice Certificate and a Registered Tax Agent. David will assist his clients, whether it is at board level, sole trader or individual investor level, with their business, wealth building strategy, superannuation, taxation and accounting needs. Your Investment Property Magazine readers voted David as: 2013 Property Tax Specialist of the Year and 2015, 2014 and 2012 Runner-Up Property Tax Specialist of the Year.