When it comes to deriving an income from a granny flat you need pay tax like anything in life. So, what are the taxes you will pay for a granny flat?
The main taxes you will pay include:
- GST on building materials
- Income Tax from rent
- Capital Gains Tax when you sell
If you are running a business for the sole purpose of selling property you will also pay GST on the sale of properties with granny flats on them.
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For the purpose of this article however I sat down with Christopher Leeson to discuss tax implications of granny flats with the sole purpose of deriving income (rent) from them.
With this in mind we jumped right in with the questions below:
Can you Avoid Paying GST on Building Materials?
Many trades people will give you a discount on labour and building materials if you pay in cash.
Basically, they might take your cash to cover their expenses but not declare this income to the Australia Tax Office (ATO).
Not declaring income for the purpose of not paying GST is illegal. And if it catches up to you, it means huge fines.
Plus, when paying cash for a “discount” your tradie will probably do this without giving you a receipt. And a receipt is what you will need as a tax deduction regarding rental income later on (I will get to this point below).
The answer is, sure, just like anything in life the choice exists to save on GST with a cash transaction. However, it comes with strict punishments and won’t help you in the long run.
How Much Tax will you pay from Rental Income?
This really is a question that is specific to your individual circumstances.
However, I hope to share some information to understand how much tax it might be for you.
Granny Flat income adds to your current taxable income
Let’s say you have just built a granny flat and you have decided to rent it out now. There are a few key records you need to have in place first:
- Receipts for every part of the build (labour and materials)
- A Depreciation report
Building a granny flat and drawing an income from it, is similar to set up costs for a business or drawing a salary from an entity (be that at job or small business).
The income; if derived from a house in your name and not in a business/company name needs to be added to your “income tax” for that year.
Based on the tax brackets set by the ATO – Tax will be paid on the rental income as your accumulative income for a given financial year.
Let’s say you earn $90,000 per year. Based on the current income tax tables you will be paying $20,797 in tax.
However, if you own a property completely in your name and you earn $20,000 a year in granny flat rent. Then you really earn $90,000 + $20,000 = $110,000 in that year.
So again, using the tax tables based on an income of $110,000 you will now be paying $28,197 in tax.
In simple terms (from the example above), with the addition of income from the granny flat you would have paid an extra ($28,197 – $20,797) = $7400 in tax
So you might think, that is a significant amount of tax due to the additional $20,000 in rental income.
However, let’s say you are retired, you own the property and it is your only source of income in a given year.
Now using the same tax tables and calculating your tax; you would owe the ATO only $342 for the year.
A significant difference! This is only when the income you made that year was $20,000 in rent.
Hence the importance to keep receipts and expenses that go hand-in-hand with the granny flat. These expenses just like any other business can be offset on the income you receive to legally reduce your yearly taxable income.
Depreciation Reports to Reduce Tax on a Granny Flat
A wise move would be to purchase a depreciation report.
They can be purchased from the companies below:
The companies above are registered qualified quantity surveyors. This means they can prepare a depreciation report for you and it will be accepted by the ATO with a ‘depreciation schedule’.
A qualified surveyor will go out to your property and create a report that tells you how much you can claim on depreciation each year.
And the reason why they’re quite important is that it’s hard to work out the depreciation on the entire property, because different parts of the flat depreciate at different rates.
For instance; let’s say the cost of the granny flat was $100,000.
Now, depending upon what the hundred thousand is spent on, you would get the report saying you can depreciate “X” amount per year for that property.
The minimum depreciation is 2.5%, as set by the government so it can only be better than that each year.
You can craft your own report (see below) however it can be tricky as the experts have a far greater depth of knowledge.
With building materials some depreciate at a far quicker rate. For example, vinyl floors and carpets would depreciate quicker.
The report you receive will be broken up into this level of detail. Carpets, framing, kitchen appliances all having an individual depreciation rate.
Let’s say the report said you had $5000 worth of depreciation for the year. This will come off your rental income.
So, if you had a rental income of $20,000 dollars for the year, the $5000 is deducted from that. And you basically pay tax on $15,000 worth of rental income instead of what you actually earned.
Depreciation Report Done by Yourself
As mentioned above, you could create your own depreciation report.
However, chatting with Chris (an experienced accountant), he mentioned that you do run a risk.
With a qualified professional conducting the report the ATO won’t really question how the depreciation schedule was crafted.
By creating the report yourself you are taking a small risk that the ATO may reject the way you have determined the figures. Therefore, spending the $300 – $600 for a report could be a wise investment.
Chris also mentioned that when spending $10,000 to $30,000 on construction there might not be that much you can save yourself in tax with a depreciation report.
When you have spent upwards of $50,000 on construction however, there may be a significant amount of money saved on tax and it is certainly worth it.
Can you claim interest repayments?
Another deduction can be added if you borrowed money to build your granny flat.
Let us say you borrow $100,000 to build the secondary dwelling and your interest repayments are $4000 for the year. That means you can add the $4000 as another deduction on the taxable income.
These all add up to help with cash flow!
Capital Gains Tax
Capital gains tax is paid on the capital gain you have made over a period of time when you sell a property. In Australia, you don’t pay capital gains tax on your primary place of residence until it starts to deliver an income.
If you rent out your granny flat you will be deriving an income from your primary place of residence. When you go to sell the property there will be a portion of the sale price subject to capital gains tax.
To find out more about this. I have a detailed post about granny flat capital gains tax that should be read through.
The greatest benefit of building a granny flat is you are adding an income producing asset to your land.
If this granny flat is on the land in which you live on, there are tax implications that need to be thought about. I hope this article was able to expand on what these are.
And that you can take this information to your accountant and pay the tax you need to pay and not any more.
The addition of a depreciation report makes a huge difference to your taxable income for the years after your construction is complete.
Understanding that every person has unique circumstances based on their income and assets that will affect how much tax they need to pay.
I also hope the example above of $20,000 in rental income per year can mean the difference in thousands of dollars in tax, based on your personal circumstances.
If you would like to discuss your individual situation feel free to give Chris Leeson’s office a call on: 1300 004 666.
And if you want to find out where to start building a granny flat yourself to save thousands check out the homepage.