How does CGT apply to the sale of a home with a granny flat

Recent amendments to the CGT provisions provide that CGT will not be triggered on the “creation, variation or termination” of a “granny flat interest” under a “granny flat arrangement” – as long as certain conditions are met. This will typically arise where the owner of the dwelling where the granny flat exists enters into some sort of “security of tenure” arrangement with the “granny flat interest” holder. These rules apply to CGT events occurring from 1 July 2021.

However, what of the CGT rules that apply where a main residence which contains a granny flat is sold or otherwise affected by a relevant CGT event?

In this case, if the granny flat was not used for assessable income producing purposes (e.g. it was not rented at arms-length to the occupier – whoever that may be) then there will be no CGT on the sale of the main residence, provided it otherwise qualifies for the CGT main residence exemption. This will be the case if the dwelling was not used for producing assessable income and if it qualified as the taxpayer’s main residence throughout the ownership period.

In addition, the adjacent land to the dwelling must be less than 2 hectares and must be “mainly used for private or domestic purposes in association with the main residence”– which would apply in the case of an unattached granny flat that was not rented at arm’s length.

On the other hand, a granny flat that was rented at arm’s length (as opposed to the occupier assisting with the payment of outgoings such as electricity and water rates) will have different consequences. In this case, a partial exemption would apply under s 118-190 of the ITAA 1997 on the basis that the main residence was also used for income producing purposes.

This partial exemption would be calculated on the basis of the extent to which the main residence was used for income producing purposes (typically, floor area space) and the period for which it was so used, i.e. the number of years in the taxpayer’s ownership period. (See the example in s 118-190.)

Also, where a granny flat is used for producing assessable income, the CGT small business concessions cannot be used to reduce any assessable capital gain in these circumstances. This is because the taxpayer would not be considered to be carrying on a business in respect of such rental activities.

It should also be understood that the CGT rules that apply to the sale of a main residence with a granny also apply where the main residence is affected by other “relevant” CGT events. These include CGT event C1 (the loss or destruction of an asset or part of an asset); CGT event E1 (the creation of a trust over the asset); and CGT event K4 (where the dwelling ceases to be a CGT asset – e.g. it becomes trading stock on being ventured into a property development activity). See s 118-110(2) for full list of relevant events.

Finally, the effect of  s 118-165 should also be noted. It provides that where adjacent land to a dwelling is subject to a CGT event, separately from a CGT event happening to the dwelling, then that CGT event will trigger CGT liabilities. In other words, where adjacent land to a main residence is sold separately from the main residence itself, then CGT will apply to that sale (e.g. on subdivision and sale of part of the backyard).

And in the context of granny flats, where that adjacent land contains an unattached granny flat, it will be caught up in this CGT liability – regardless of whether the granny flat was rented or not. This is because the rule in s 118-165 applies to capture a gain or loss where a CGT event does not happen to the whole of the main residence (including adjacent land) – regardless of how that adjacent land has been used.

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