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Granny flat arrangements within the context of the gifting rules

Retirees wanting to downsize their home may consider the option of living in a granny flat, or an extension to / spare room of a relative or friend’s home.

Money, the transfer of an asset or a combination of both, may be given as consideration for the right of accommodation, or a life interest in a property. For social security (including DVA) purposes this is called a ‘granny flat arrangement’.

Under social security rules, a person can give away assets or money of up to the harsher of $10,000 per financial year, or $30,000 over a five year rolling period. However, Centrelink may allow a greater amount to be given away where the person pays for a granny flat arrangement. Any amount exceeding specified limits as allowed by social security will fall under the deprivation rules, commonly referred to as ‘gifting.’ Where an amount is ‘gifted’ it is assessed for the social security means test for five years.

Payments that do not fall under ‘gifting’

Centrelink recognises that granny flat arrangements are usually family arrangements. Payment for construction costs to provide accommodation for the person, or the transfer of property (such as the family home to the grantor of the right), is not considered ‘gifting’. However if the amount paid exceeds the construction costs, or is in addition to the property which has been transferred, Centrelink will apply the reasonableness test.

The reasonableness test

Where the reasonableness test applies, amounts up to the value of the granny flat interest do not fall under gifting. The value of the granny flat interest is the greater of the reasonableness test amount, and the:

  • value of the property that was transferred or
  • value of property purchased for the grantor or
  • construction costs incurred.

The reasonableness test is a quasi-actuarial calculation to value the granny flat interest for social security purposes.

It uses a conversion factor that is based on the person’s age next birthday and the maximum partnered pension rate at the time the granny flat arrangement is entered into:

The annual combined maximum partnered rate x conversion factor

The calculation is the same whether the person is single or partnered. For couples, the conversion factor is based on the younger spouse’s age next birthday.

Example 1

Janice, aged 69, pays her son Justin $800,000 for the right to live in a granny flat to be built in Justin’s backyard. Construction will cost $150,000. As the amount paid for the granny flat arrangement exceeds $150,000 the reasonableness test will apply. The conversion factor based on 70 years is 17.36 and the annual combined maximum partnered rate at that time is $39,923.60.

The reasonableness test is calculated as:

 

$39,923.60 x 17.36 = $658,353.70

The value of the granny flat interest is calculated as $658,353.70, being the greater of the reasonableness test amount and construction costs. The amount of $141,646.30* (i.e. $800,000 less $658,353.70) will be considered a ‘gift.’

Example 2

James, aged 80 and Anna, aged 78, transfer the title of their home valued at $600,000, plus $100,000 to Katy, who agrees to grant the couple a life interest in the home. As money was paid in addition to the transfer of property, the reasonableness test will apply. The value of the granny flat interest is $600,000, as this is the greater of the value of the property transferred and the reasonableness test amount calculated at $427,182.52 ($39,923.60 X 10.70). The $100,000* will be assessed as a gift.

*Deduct $10,000 per financial year that is allowed to be gifted (once per amount), up to a maximum of $30,000 over a five year rolling period.

Terminating a granny flat arrangement within five years

‘Gifting’ may apply where a pensioner terminates a granny flat arrangement if it was expected at the time of commencement, that the pensioner would leave the accommodation within five years. For example, where the pensioner needs aged care. The value of the granny flat arrangement will be assessed by Centrelink for the remainder of the five year period.

Example 3

If Janice from the first example, left after three years, Centrelink may include $658,353.70 for the next two years in Janice’s means test calculations.

With respect to a granny flat arrangement, it’s important to investigate all details of the arrangement before it’s entered into, and to determine whether the reasonableness test will apply.

You should also consider the advantages and disadvantages of the strategy including any tax, social security, and estate planning impact.

Pensioners who ‘gift’ to gain or retain more Age Pension may actually receive less than what they give away.

‘Gifting’ may be an option for self-funded retirees who have financial resources to spare, however pensioners who depend on social security should think carefully before ‘gifting’ large amounts of cash or other assets.

To find out more please contact your adviser.

Source: BT