Victoria is the latest state to overhaul restrictions on backyard homes that can generate income. But experts warn there are legal, tax and funding challenges.
A building boom is reshaping the nation’s backyards as the easing of planning and construction rules creates opportunities for investors and homeowners to boost income or for families to extend their homes.
Victoria is the latest state to announce sweeping changes to restrictive planning codes – no permit needed to build a granny flat or second small home of less than 60 sq m – in a bid to ease housing shortages, boost income and improve the ability to provide intergenerational living.
Investor Andy Oliver pictured with partner Elisa Sko. Andy has built his wealth through the construction of granny flats. Martin Ollman
But experts warn a backyard development can also open the door to planning, tax and legal problems, including tricky issues for will makers.
There are already more than 80,000 backyard buildings around the nation, according to analysis by research group Archistar Property Platform. Those numbers are set to accelerate as more states ease regulations in a bid to boost accommodation and ease rental problems
“Demand is massive,” says Dean Roller, director of DIY Granny Flat, who says national construction has doubled in the past 18 months.
More people working from home and historically low rental vacancies caused by rising immigration and falling new dwelling completions, according to SQM Research, are driving demand.
Structures typically range from pods of less than 20 sq m used as home offices (with no plumbing) through to self-contained flats of less than 60 sq m, specialists say.
Andrew Oliver estimates his Canberra granny flats, or self-contained apartments, are generating after-tax returns of about 10 per cent plus strong capital growth in the booming local property market.
Oliver, whose full-time job is in the federal public service, has bought two properties with generous backyards – renovating the existing homes and building each of them a one-bedroom flat fenced off from the main house.
“It’s absolutely paying its way,” Oliver says about the combined rental from the properties that are rented separately but on the same legal title.
Frank Walmsley, a director of Canberra Granny Flat Builders, says average rentals of $500 are cheaper than houses and apartments and a long-term investment for homeowners.
For Andrew Wallace, a father of three children aged between 12 and 18, the biggest problem he had building a granny flat for his widowed mother was waiting the six months for building approval from the local council.
“It has been a ridiculous amount of time for a simple structure. So frustrating, particularly when I can get financing in a heartbeat,” says Wallace about the one-bedroom, self-contained apartment.
His mum, Betty, 82, recently sold her home and wants to live with her son and grandchildren rather than in a nursing home.
Andrew Wallace had to wait six months before council approved the construction of a granny flat for his widowed mother Betty. Alex Ellinghausen
Those building in a backyard also need to balance any extra income with the loss of amenity and the financial risk of falling property prices not covering building and other costs.
Costs range from about $20,000 for a DIY flat pack to more than $200,000 for a custom-built apartment, which includes surveying, planning, engineering, materials, labour and tradies.
Janine Rockliff, a director of property consultancy Herron Todd White, adds: “Purchasers are wary of signing new construction contracts with cost increase clauses. Also, securing a builder who’s available to start in a reasonable timeframe to reduce holding costs is a challenge,” she says.
Funding methods can range from mortgage top-ups to lines of credit, credit cards or personal loans, according to Canstar, which monitors lending rates. For a top-up loan of about $100,000, the cheapest rate is about 6.7 per cent, followed by a line of credit at 8.5 per cent. Credit cards and personal loans cost about 17 per cent and 11.6 per cent respectively.
A flat rented to granny (or another relative) for a nominal amount is not regarded as a commercial transaction and income and expenses will not be taxable or deductible, says Mark Chapman, a director of tax specialist H&R Block.
Where commercial rents are charged, Chapman says expenses incurred in running the flat, such as land taxes or borrowing costs, are deductible.
It might generate a taxable profit – or loss to claim against other income – depending on the circumstances, he says.
Sharon Grice, a director of consultancy William Buck, says those who earn income by renting out a granny flat will forfeit the capital gains tax exemption on their primary residence.
As illustrated in the table, a house on 400 sq m is valued at $1 million before a 60 sq m granny flat (15 per cent of the property) is rented. The property and granny flat are worth $2 million when the property is sold.
The capital gain on the sale of the property is proceeds minus cost base – which is market value at the time the property is first used for producing income.
“You will also need to keep details of expenses relating to your home after the date it started producing income,” Grice says.
CGT in this case is estimated to be about $150,000, or 15 per cent of the $1 million gain on the sale.
Victorians who rent out flats for short-term stays, such as through Airbnb and Stayz, are likely to be liable for a 7.5 per cent levy. NSW could follow.
But there is generally no tax liability where an older person, typically a parent or elderly relative, pays the homeowners for the “right to occupy” part of their home for life.
“Laws have been changed so there is generally no CGT liability,” says Chapman. To avoid the tax, a range of conditions must be met, including that the arrangement is not commercial.
Investors building a granny flat or small house will need to apply for an Australian Business Number and could be liable for goods and services tax (GST).
Ken Fehily, director of GST specialist Fehily Advisory, says “in most cases, the investor will be adding to residential land with an existing property they already own”.
“As they don’t add GST on to the residential rent they charge, and can’t claim GST back on their expenses, there is generally no need to register for GST.”
Most granny flats are built as extensions to the family home or separate buildings on the same title. The flats cannot be sold separately from the main residence unless the land is subdivided.
Jane Baddeley, a partner with Hall & Wilcox, says those planning a later subdivision of the house and another dwelling need to design and build in a way that facilitates a planning permit, such as direct access and services connections. Alternatively, developers might split a property title before construction, then build on the newly created lot.
Baddeley says elder family members transferring the title of their property to a younger family member in exchange for care and accommodation in a granny flat should have a written agreement recording their life tenancy/interest in the property.
“The elder could also grant an interest in the property to the other family member, with the parties sharing title as tenants in common, provided consideration is given to any impact on the elder’s social security entitlements” she says.
Residents worried about a neighbour building in their backyard can object to the grant of planning permits by the local council.
William Moore, a partner at Hall & Wilcox, says parents who switch their home for a granny flat with a child need to ensure any other children are treated fairly in their will.
That might mean bequeathing other children additional money to compensate for the added value created for the child living in the family home by the granny flat.
“Have a family discussion and document the agreement so there are no disagreements when the parents die,” Moore says. “Leave a legacy, not a liability,” he says.
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