Granny Flat arrangements — when will they be appropriate?

Introduction

“Granny flat” arrangements are becoming increasingly popular. Too often however a granny flat arrangement will fail to deliver what the parties were expecting. On many occasions the arrangement leads to  family disputes or even to litigation.

There are a number of key considerations that family members need to take into account when entering into a granny flat arrangement.

This article focuses on those key considerations and includes a  checklist for practitioners to follow when considering a granny flat arrangement for their clients.

Key points/how does it affect you?

  • To confirm the key questions to be raised for you to determine whether a granny flat arrangement is appropriate in a particular client situation.
  • If a granny flat arrangement is appropriate for the specific circumstances then there are recommended aspects that  an  adviser should address when documenting the arrangement.
  • This article will assist advisers to develop their own checklist to use when acting for clients that want to put in place a granny flat arrangement.

What are granny flat arrangements?

The following article focuses on “granny flat arrangements” that involve the grant of a “granny flat interest” as the term is defined in the Social Security Act 1991 (Cth).[1]  The elements of this definition are noted below.

It is also relevant to note that the phrase “granny flat” has its own meaning in a real estate context being a self-contained living  area  that  is  part  of  an  existing residential dwelling.

Although a granny flat interest will often relate to a separate living area, it does not have to. A granny flat interest can be created where there is no separate living area.

Definition of granny flat interest

A granny flat interest is where the person resides in a private home and acquires for valuable consideration, or has retained a right to accommodation for life, in the residence or acquires (or has retained) a life interest in the residence.

Importantly, the payment made or the consideration provided by the person (invariably the parent) is generally an “exempt asset” for social security purposes. Therefore the deprivation or gifting rules do not apply. The rationale for this approach was described by Centrelink as follows:

We don’t use market value to work out how much a granny flat interest is worth. Instead, we value it at the same value as the assets you transferred or paid if you are:

  • transferring the  title  of  the  home  you  live  in  to someone else and keep a lifetime right to live in that home or in another home [This applies if your home was or would have been totally exempt from the asset test]
  • paying to:
    • build a granny flat on someone else’s property C   convert  someone  else’s  home  to  suit  your needs and getting a lifetime right to live there, or
    • buying a property in someone else’s name and get a lifetime right to live there

[Provided you pay in one of these ways and do not transfer additional assets as well, no deprivation will occur.][2]

If an additional payment or consideration is provided, Centrelink will apply the “reasonableness test”. This test is based on the combined partnered rate of the annual pension and is multiplied by the age-related factor. If the payment or consideration being provided exceeds the reasonableness amount, then there will be a reduction in the pension.

The typical situation is where the parent transfers the home to their child or where the parent pays for renovation of the house on the child’s property to create a self-contained living area.

Where the parent is a self-funded retiree who is not reliant on the Commonwealth pension, options other than  the  creation of  a  granny flat interest would be preferred. Those options would include the parent being registered as a co-owner (either as a joint tenant or as tenants in common). This option may have stamp duty and taxation implication for the parties.

The most common and problematical situation is where the parent is a pensioner so is subject to Centrelink rules including the deprivation (gifting) rules. As indicated above, in certain cases there is a specific exemption of those rules to the grant of a granny flat interest.

The challenge when advising in these situations is evident, especially when acting for the parent. It will be critical for the exemption to apply and for a granny flat interest to be created. This is because the parent will need to continue to receive the pension and will need their pension to be unaffected by the gifting rules.

To achieve that result it necessarily means that the parent is restricted to receiving a life tenancy or life interest in the property. Although this life interest can be transferred to  any replacement property, the level of faith being placed by the parent in the arrangement is significant.

Importantly the granny flat interest cannot be revoked by the child as the owner of the property just because they want to sell. The child can either transfer the life tenancy or interest to another property or compensate the parent financially for losing the granny flat interest. The property can also be sold subject to the life tenancy or life interest but such a sale will be unlikely where the purchaser is an unrelated party.

Despite these protections, the parent transferring their property to a child for simply the grant of life interest or tenancy is taking a step that assumes that the life tenancy or interest will deliver important personal benefits for them.

As  described  by  one  commentator, [3]   there  is  an element of counter intuitive regulation with these rules. The situation is that there is a transfer of property by the parent for no payment and the only right obtained by the parent is a right of residence in the property. Such a situation is at odds with the well-established equitable principles in relation to constructive trusts and resulting trusts.

An adviser for the parent must recognise the context and carefully address the risks for the parent who is making the gift in exchange for the right of residence or life tenancy.

When is a granny flat arrangement appropriate?

There are situations when the question of a granny flat interest will be appropriate.

The following are circumstances that will reinforce the suitability of the arrangement:

Ideally there would have already been a history of having recently resided in the same residence, thereby confirming such living arrangements can work for both parties.

If the factual context is consistent with the above, then a granny flat arrangement could well be appropriate. If the situation being considered does not include the above elements, there will need to be a close assessment as to the desirability of the parties entering into a granny flat arrangement.

What are the elements  of a deed  of family arrangement for a granny flat?

If the parties proceed with the granny flat arrangement, it is critical that the arrangement be documented. To cover the required issues, the relevant deed of family arrangement will be quite detailed.

It is also critical that each party receive independent advice, both legal and financial. Clearly financial advice for the parent will be critical but financial advice for the child will often be just as important. For instance where the child is likely to also be a pensioner or social security benefit recipient in the short term, the transfer of the parent’s home may have an impact on those benefits as a result of the assets test.

The following aspects should be covered in some detail in the deed:

  • a detailed statement of the relevant background including why the parties are entering into the deed and what has occurred in the past
  • the background will include a statement confirming that each party has received independent advice
  • a detailed statement of the obligations of the carer or child, with this statement describing the types of  care  and  tasks  that  are  to  be  provided and undertaken
  • confirmation as  to  who  is  responsible  for  the payment of property outgoings and service charges
  • confirmation of the insurance obligations, including insurance of their contents by the parent
  • conditions dealing  with  holidays, absences and periods of respite
  • a list of the circumstances where the parties contemplate the arrangement would end including the following:
    • where there is a need for additional care for the parent above what the child can provide
    • a separation of the child from their partner
    • insolvency or death of the child (or the child’s spouse)
  • the deed should then specifically cover the consequences of termination of the arrangement. There will need to be recognition that there should be refund of the equivalent value being made to the parent
  • The child has demonstrated an ability to provide care and support for the parent including assisting with meals, shopping and travel arrangements for their parent.
  • The parent presents as being in reasonably good health and there is no apparent need for the level of care that they will require to escalate in the short term, especially with a condition that will require regular medical care.
  • The arrangement is not driven by the financial needs or objectives of the child. Instead there is a primary objective of providing suitable accommodation for  the  parent  with  their  family  on  a long-term basis.
  • The  parent  and  child  (and  preferably  also  the child’s  spouse)  have  a  very  close  relationship.

If the parties reach the stage of finalising a deed of family arrangement one of the important additional aspects to consider is the impact that the deed will have on their estate planning. A granny flat arrangement will have significant implications on the estate planning for both parties.

In essence, the parent is disposing of a significant asset during their lifetime which results in their estate being significantly depleted. In relation to the child, they are receiving a significant asset as part of their inheritance in advance.

There is likely to be some interest and perhaps concerns from any siblings of the carer/child that received the benefit from their parent. The recommendation is that any other siblings be informed and consulted in relation to the option of arranging a granny flat interest.

It is clear that the granting of a granny flat interest can also achieve the parent’s objective of providing specific and significant support for one of their children.

It may also be that there are concerns of the parent that if the benefit was provided to the child under the will, that provision could be the subject of a claim for further provision by any other child that is not party to the deed of family arrangement. If the parties have a connection with  New  South Wales,  the  entry  into  a granny flat arrangement is likely to be relevant under the notional estate provisions.

Whilst  this  objective  of  providing  a  benefit to  a particular child may well be a sought after outcome of creating the granny flat interest, it would only be in the very rare circumstances (if at all) that this estate planning  objective should be  the  determinative factor  in entering into the arrangement. The important matters referred to above would also need to be considered.

Conclusion

For granny flat arrangements to be workable for both parties and for the review of the arrangement to be kept out of the courts, there will need to be some serious assessment and consideration of whether or not the arrangement is appropriate for the particular clients.

Even where appropriate, the arrangement would need to deal with a possibility of there being a change in circumstances for the parties.

In the right context and after thorough and careful advice, a granny flat arrangement can achieve significant and beneficial outcomes for the parties. The benefit of a parent being able to live in a family home for as long as possible has both significant financial and personal benefits. The child/carer receives a significant financial benefit but in return they have also taken on a significant care responsibility. There is also an important sense of fulfilling a common personal goal that allows their parent to receive care in the preferred place of a family home.

To achieve these outcomes advisers will need to walk the parties carefully through a proposed granny flat arrangement to ensure that these objectives are achieved.

To learn more about if a granny flat arrangement is right for you and your family, contact our estates team.

Written by David Toole and Golnar Nekoee. First Published in the LexisNexis Retirement & Estate Planning Bulletin.

[1] Section 12A.

[2] Department of Human Services, Granny Flat Interest, 27 August 2017, www.humanservices.gov.au/individuals/enablers/granny-flat-interest

[3] R McCullagh, The tangled web of granny flats, 22 August 2015.