Elderly Australians and their families will benefit from a new capital gains tax – CGT exemption for granny flats, under changes to be included in today’s federal budget.

Treasurer Josh Frydenberg and Housing Minister Michael Sukkar have announced plans to either waive or reduce the CGT currently paid on value added to a home by building a granny flat, but only where a formal written agreement is in place between the occupant of the flat and the owner of the main home.

CGT exemption for granny flats

The government expects that about 3.9 million pensioners and 4 million Australians with a disability will become eligible for the new CGT exemption for granny flats.

The rules, which are set to apply from July 1, 2021, and are subject to legislation passing Parliament, will cover agreements entered into because of family relationships or other personal ties. Commercial rental arrangements are excluded.

Does CGT currently apply to granny flats?

Under current tax laws, a homeowner may have to pay CGT where there is an agreement for a family member to reside in their home, such as when an older parent lives with a child, either in the same home or a separate building such as a granny flat.

The tax consequences have been a deterrent to some families establishing a formal and legally enforceable agreement, leaving no protection for the elderly if a relationship breakdown takes place.

Interests in granny flats can affect social security entitlements, so those entering into accommodation arrangements are encouraged to document them fully in writing.

Benefits of the CGT exemption

The budget move is designed to address the tax consequences, which the government believes can be an impediment to families creating formal and legally enforceable granny flat arrangements.

‘‘When faced with a potentially significant CGT liability, families may opt for informal arrangements which can leave open the risk of financial abuse and exploitation, for example following a family or relationship breakdown,’’ Mr Frydenberg said in his press release.

‘‘Under the measure, CGT will not apply to the creation, variation or termination of a formal written granny flat arrangement providing accommodation for older Australians or people with disabilities.’’

It stems from moves to simplify granny flat taxation arrangements, as recommended by a 2019 Board of Taxation report, and amid efforts to end elder abuse and financial crimes targeting older people.

What the experts say

Tax Institute senior advocate Robyn Jacobson said the announcement of the CGT exemption for granny flats was welcome after years of concern and uncertainty for taxpayers.

‘‘It is a shame the changes won’t be given immediate effect from today, as this would provide peace of mind to older Australians and those living with a disability. It would also relieve their adult child of adverse tax consequences,’’ she said.

But Ms Jacobson said only one of two CGT issues was being addressed and she questioned whether the legislation would preserve the main residence exemption in CGT rules. ‘‘One hopes the exemption will be broad enough to cover all of the various arrangements that apply to granny flats because not all are straightforward,’’ she said. ‘‘Some are paid upfront, some are paid over time, some are paid for later once the older parent receives funds such as an inheritance.’’

Tax and Super Australia tax counsel John Jeffreys said the exemption would be popular. ‘‘Granny flats enable a family to care for an older or disabled family members. Yet building this second dwelling usually increases the overall value of the family’s home and … the family then has CGT on this gain if they later sell their home,’’ he said.

CGT exemption for granny flats information

If you need clarification or assistance with the CGT exemption for granny flats, please contact one of our tax accountants.