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Thank you for your response to my granny flat question last year (see below).
We have now commenced building the granny flay and I am reconsidering whether the granny flat should initially be treated as a secondary dwelling.
Our family circumstances are such that it makes sense for my Mum to move in for a period of time (probably around 3 months) when the granny flat is completed in October 2014. I have also done some calculations and with the timeframe I intend to own the property (20 years) and the fact I would expect for at least 5 years of that time the granny flat would not be income producing, the CGT implications of treating the granny flat as a separate dwelling appear to outweigh the initial tax deductibility benefits.
With this in mind a few more questions if I may:
1. Will the fact the Council has described the studio/granny flat as a “secondary dwelling” in the development approval documentation (as per the NSW Affordable Rental Housing Policy – SEPP No. 70) impact on us initially treating it as part of our main dwelling? (or does it come down to a consideration of TD 1999/69)
2. As I mentioned there will be a garage (and family room) below the granny flat which will be exclusively for our use. How should I calculate the amount of the building costs that are tax deductible (since the granny flat is the main reason for the development I plan to include all fees related to the development, all set up costs such as demolition, excavation, footings , the full cost of the build and reduce this amount by an estimated cost of building the garage/family room)
3. Will the land component under the granny flat be subject to land tax under any circumstances?
4. I have another investment property with an asbestos roof I am considering replacing – I understand that removal of the asbestos will be deductible but can I also claim the cost of the new roof as an immediate tax deduction (I have owned the property for 9 years and have had issues with leaks from the roof)
Previous question
We own a 280sqm block with an existing house. We bought this property in
January 2011 for $1M.
We rented out the property for the first 18 weeks of ownership.
The property is now valued at $1.1M
We plan to build a garage with a self-contained apartment above (the studio
will have 35sqm living area of a total living area of 160sqm). The land
under the garage/studio is approximately 50sqm.
After reading your article in Nov 12 API article I have few questions:
1. I understand that developing the granny flat is a capital expense as per
PR: 48928, however can I start claiming tax deductions on interest paid on
borrowings related to the construction (DA approval, professional fees,
construction progress payments etc..) if we intend to rent it immediately
upon completion and it is a short build (less than 3 months).
2. If we decide to treat the studio as a separate dwelling can we claim a
tax deduction on borrowings related to the land component of the apartment.
This seems only reasonable since we stand to pay CGT on the land it is
built on. If the land component is tax deductible, 2 further questions:
(a) is the land component based on the OSR unimproved value ($550K) or can
it be based on a bank valuation ($850K); and
(b) when can we start claiming interest on the land component (ie. now we
are drawing up plans, when construction starts or when it is first rented
out).
3. Is it possible to scrap the value of the existing garage and any other
fixtures removed as part of the construction (I have a depreciation report
from when the property was initially rented out).
4. We intend to own the property for some time and expect a family member
will live there at some stage (possibly in 10 years time). Since the
property was initially rented out we are comfortable further exposing it to
CGT and reduce the CGT impact by all ongoing expenses. Is there anything
else we should consider in deciding whether the studio should be regarded
as a separate dwelling?
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Answer:
Answer by julia on Sun 30, Jun 2013 12:08pm:
This is quite an oversized question so I will cut to the chase and
refer you to references when I can. I am going to assume you fully
understood the API article and the ramifications of treating the granny
flat as a rental right from the start, which will be necessary in order to
claim interest during construction. You would miss out on the resetting of
the cost base anyway because the whole property was first a rental but once
it is considered a separate dwelling from your home the untested theory is
that it cannot be covered by your main residence exemption even when used
as part of your home. How you use it when it is first built determines
whether it is a separate dwelling or not.
1) You can certainly claim the interest on the loan relating to the granny
flat and the land underneath right from the time you commit the property to
the project of creating a granny flat to rent. This is based on Steele’s
case and is stated in the ATO’s rental property guide. No 3 months limit
just a requirement not to change your mind or stop the project. Delays by
council and builders are fine as long as they are simply part of the
project not you stopping the project.
Just restating here that in order to claim interest before you put the
first tenant in the property you have to treat the Granny flat as a rental
right from that point so it will always be considered a separate dwelling
from your home which in theory (untested) means the main residence
exemption can never apply to it at the same time as you are covering your
home.
2) If you have kept the nexus tidy on the original borrowings for the
property ie no redraws. Then you apportion the original purchase price
between your home and the land being used by the tenant ie under the studio
and courtyard etc if applicable and apply this percentage to the original
borrowings. Note the value of the garage that seems by your discussion is
going to be demolished can still be included in the percentage used to
apportion the interest and in the Granny flat’s cost base.
a) Based on portion of original price paid
b) From date committed to the project of creating a rental ie now
3) No as not used to produce income immediately before demolition reference
ID 2010/35 http://law.ato.gov.au/atolaw/view.htm?docid=%22AID%2FAID201035%2F00001%22
4) I am comfortable with your choice only the future will prove whether it
was the right one, you can see the pros and cons in the article. Just make
sure you do section 110-25(4) to death on both properties ie keep records
for any expenses you have not otherwise claimed as a tax deduction (ie when
the family member lives in the granny flat) even light globes, cleaning
materials, lawn mower fuel.
Re anything else to consider – If your current home is covered as
your main residence when you die then your heirs will simply inherit it at
market value at DOD so the CGT liability for the 18 weeks it was rented out
at the start is forgiven and forgotten. So too would all the CGT on the
granny flat if it is not being rented out at the time and was initially
considered to be part of your home instead of a separate dwelling ie not
treated as a rental at the start as per the API article. If there is a
possibility you will continue to live in this house in your retirement the
scales are now more tipped to try and treat the granny flat as part of the
home initially which of course means no interest deduction until a tenant
goes in there and the tenant should not go in there upon completion, it
needs to be used as part of your home first.
Answer
I am please you have decided to treat the granny flat initially as part of your home. I think the odds are in favour of that being the best choice. I would like to point out that in the first question I didn’t realise that the garage underneath was going to be used as part of your home ie not by the tenant in the granny flat. So the whole apportioning area of the answer needs to be reconsidered but now we only need to do that on the basis it is part of your home.
To the question of the interest on the loan for the land underneath: You can apportion that part of the loan out on the basis of its value when you purchased the original property but then you would have to apportion it on the ratio between the number of square metres of the building used to produce rental income and the portion used as part of your home. When it comes to the construction costs loan you could apportion this on the basis of actual costs.
As the granny flat is initially considered part of your home the whole tax consideration works just like you were renting out rooms in your home so is governed by IT 2167 http://law.ato.gov.au/atolaw/view.htm?DocID=ITR/IT2167/NAT/ATO/00001
1) The ATO may try and give you some grief about this if it suites them but mere use of words cannot override a fact. You also have TD 1999/69 and the fact that it is also on one title. Further, as it is built above a garage and room you will use as part of your home you should be very comfortable arguing it is one dwelling.
2) No you are going to have to be more reasonable that that. The ATO would require a “reasonable” method of apportionment and as you can read in IT 2167 that would be looking at the number of square metres used for the rental and number not. You could apply this method to the costs that are spread equally over the project ie council fees and then pull out separately the actual costs of building the granny flat as I imagine up stairs is going to have a higher building cost than downstairs because of the bathroom and kitchen.
3) Sorry land tax varies from state to state so I have very little knowledge of that. I understand that land tax is assessed by the state revenue office, you don’t have to tell them anything, no return to lodge like income tax. Though if you leave the country they need to be advised. Anyway, from a practical point of view I just can’t see them trying to assess it.
4) I recommend you don’t use the environmental protection concessions here, they do not apply if the item needs repairing anyway. They are an incentive to remove asbestos when you wouldn’t otherwise. As long as the property did not need repairing when you purchased it and that seems reasonable after 9 years then you would be entitled to claim the removal of the asbestos and the replacement with the new roof as an outright cost, a repair, of earning the rental income anyway. Make sure you do receive some rental income that year and that the replacement roof is similar in materials to asbestos ie don’t try to claim a tiled roof just go for metal. Don’t let the ATO try and tell you it is a replacement in its entirety and therefore not deductible. The roof requires the 4 walls to hold it up so it is the whole building that is the entirety.
