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The tangled web of granny flats

Richard McCullagh - Saturday, August 22, 2015

Succession issues, equitable trusts, security of tenure, reduced pension entitlements and liability for capital gains tax – these are some of the threads of the web that can unexpectedly ensnare family members in a granny flat arrangement. The decisions in Daunt v Daunt [2015] VSCA 58 and Hayes v Hayes [2015] QSC 88 are but recent examples of granny flats cases in Australia going back at least to Malsbury v Malsbury [1982] 1 NSWLR 226.

Accommodation options for elders

An increasingly popular accommodation option for the elderly is to move in with their young family, or vice versa. This may seem more appealing than staying home alone or moving to a retirement village or a residential park. It avoids having to get a reverse mortgage if needed to pay for care at home, paying departure fees to and sharing capital gains with a village operator or facing the uncertainty of rental increases in a park. 

This all sounds great until purchase money for, or legal title to, the home gets intermixed between co-habiting generations in ways that might later be regretted. Undoing the arrangement can be very costly and taxing on family emotions. Though the net may be cast much wider to involve friends or distant relatives rather than the immediate family, the elderly financier or transferor will be referred to here as the ‘parent’ and the homeowner as the ‘child’. 

Family factors

The parent is likely to be asset-rich and income-poor seeking stability of location, company and care. In contrast, the child will be flush with income, paying off debt secured over their home and keen to pursue new career, educational and occasionally domestic opportunities. 

Quite apart from the usual downward vicissitudes of life - disability, incapacity, unemployment, divorce and death - it is the intergenerational pooling of assets in the context of divergent needs and wants of co-habiting family members of disparate ages that make the best intentioned of ‘granny flat’ arrangements so fragile. A survey of the litigation shows that it is actually the de-partnering or re-partnering of either the parent or the child that most commonly brings the whole thing asunder.

In the interim, pensioners may experience a surprising reduction in their entitlements from Centrelink and the homeowner might receive an unexpected assessment for capital gains tax from the ATO.

Intergenerational family accommodation agreements

Traditionally known as ‘granny flat arrangements’, they might be more accurately re-named ‘intergenerational family accommodation agreements’ (IFAA’s). The degree of ‘agreement’ may range from the most informal without any thought about the future, through to something a lawyer has been retained to draft. It is to the latter that this article is directed, and what can be done when a formal and comprehensive agreement is wanting.

Legal genesis

Legally, problems arise in the first instance when there is a mismatch between (a) the parent’s financial contribution to buying or renovating the house and (b) he or she not being a registered proprietor, or not in proportion to that contribution. The same result follows where the parent has transferred the title of their house to the child for less than current market value. 

This reduced or lost equity may frustrate the parent’s financial ability to relocate if, for example, he or she can’t stand the noisy grandkids after all, or on having to move into residential aged care. Further, testamentary intentions may be thwarted – much to the chagrin of any other children and beneficiaries under a will or entitled on intestacy or eligible persons intending to make a family provision claim. 

Tenants in common

The best way to set up an IFAA is as tenants in common in proportion to the financial contributions made by the parent and child respectively. If push comes to shove, application can be made to the Supreme Court for the appointment of trustees for the sale of the property to enable the parent to retrieve his or her contribution, assuming property prices have not declined overly in the interim. However, traditional lenders do not favour this and are unlikely to advance funds.

Setting up this arrangement will involve legal costs and ad valorem duty on the respective shares but the security of tenure for the parent is as good as it gets. If the child can borrow against the property later to finance the return of the financial contribution to the parent this avoids the angst and cost of appointing a trustee for sale. 

Owner occupation attracts the usual principal residence exemptions for pension and capital gains tax purposes. The parent’s share can devolve under their will or on intestacy. Under this scenario, the IFAA has little work to do but is still useful to record the intent of the parties and details of the sharing of domestic costs and the provision of care.

Joint tenancy

Joint tenancy has the same features as tenancy in common outlined above with one important difference. On the death of the first tenant the whole property passes by survivorship to the surviving tenant and not through his or her will or on intestacy. However, the parent’s interest is still available under a family provision claim as notional estate. As it is likely the parent will die first, any siblings unaware of this arrangement will no doubt be very put out upon discovery. 

In Daunt v Daunt the parents owned their home as joint tenants. The mother transferred her share to one son for nil consideration, apparently based on advice from Centrelink. When the father died the whole passed passed to the son. His brother commenced unsuccessful proceedings alleging undue influence and unconscionable conduct. From a succession perspective, joint tenancy is best avoided except in the case of an only child.

Lease and loan

A long term lease and loan arrangement is very common in retirement villages and can work in a private home. If the parent is not a registered proprietor, a registered lease for the life of the parent gives excellent security of tenure and a loan can provide for the enforceable repayment of his or her financial contribution. There is no stamp duty and it is not expensive to implement. 

The loan provisions in the IFAA may oblige the child to repay in full when the property is sold or for any reason after an agreed notice period (eg if the parent has to move into residential aged care). It should provide that the loan be secured by a mortgage or protected by a caveat and that it binds the child’s estate and enures for the benefit of the elder’s estate. 

A clause should preclude the child from offering the house as security for (further) borrowing without the parent’s prior written consent. Hopefully the parent has appointed an enduring power of attorney other than the child solely.

However, there are two major downsides if a mortgagee is involved or the parent is a pensioner.

First, lenders will not consent to registration of the mortgage, unless as a second mortgage usually subject to a deed of priority, and certainly not the lease. 

Mortgagee or not, the IFAA should provide that the child consents to the lodgment of a caveat by the parent and agrees not to lodge a lapsing notice or otherwise seek its withdrawal prior to permanent vacation by the parent and repayment of all monies owing. 

Second, if the parent is a pensioner, Centrelink will characterise the amount of the loan as a financial asset that attracts deemed income. Anecdotally, the same treatment will apply to the parent’s transfer of the whole title to his or her house to the child for less than full market value, including if the balance is payable by installments. Curiously, while the shortfall will be a ‘gift’ the transfer of the whole title for nil consideration is not (see below). 

Right of residence for life

The IFAA should at the very least provide for the parent to have a right of residence for life in the home protected by a caveat. If so, Centrelink will allow for a right of compensation payable by the child to the parent if the property is sold before his or her permanent vacation without this being treated as a gift. This may be satisfactory if the amount of compensation due is the same as the original contribution. Arguably, though, the quantum of loss would reduce over time as life expectancy diminishes. Even if not, there are other drawbacks.

The compensation permitted by Centrelink without loss of pension will be of no comfort whatsoever to beneficiaries of or claimants on the estate of the parent if still in residence on death. No longer will there be any loss for which to compensate. This also applies if the parent moves out, for example, on having to move into residential aged care.

Equitable trusts

If the parent is not a registered proprietor in proportion to his or her financial contribution, equity will deem the child to be holding the corresponding share on trust for the parent unless it can be shown that a gift was clearly intended. This could apply where parent and child are shown as tenants in common in equal shares, or joint tenants, on the title but the parent contributed more than half the cost. This may be provided for in the IFAA as an express trust and not a gift to the child. 

However, in the case of a pensioner, Centrelink will deem the difference between financial contribution and the share on title to be a gift to the child

Failing such detailed documentation, a court may still find a common intention on the part of the parties by conduct that the contribution was not a gift, giving rise to a resulting trust in favour of the parent.

Failing that, a court may impose a constructive trust on the basis that it would be unconscionable for the child to, for example, sell the property, evict the parent and not account for his or her financial contribution to the original acquisition. The same may apply if, without attributable blame, the parent wants or needs to move out after a relatively short period of time.

In Hayes v Hayes, parents paid for the construction of a dwelling on land owned and occupied by their daughter. In the absence of written IFAA but based on the conduct of the parties over 28 years, the Court found that the parents made a gift of the dwelling. The son’s costly claim asserting a constructive trust failed.

Another avenue is proprietary estoppel. Equity will hold the child to account if the parent can show that the child represented that a right of residence for life was being offered, that this was relied upon in he or she making the financial contribution or transferring title and that detriment has resulted in the form of the double loss of accommodation and money. 

In Pobjoy v Reynolds [2013] NSWSC 885 (1 July 2013) a 79 year old pensioner mother was induced by her daughter to sell her current home and by a property for $121,000 in the name of her daughter and son-in-law. Divorce occurred and the property was old under family court orders. The mother obtained a declaration based on proprietary estoppel that the daughter’s subsequent property was subject to an equitable charge in her favour for the funds advanced to be protected by a caveat.

These are all costly remedies to pursue ‘after the fact’ and an IFAA should if possible be drafted ‘before the fact’ to deal with these contingencies.

‘Granny flat interest’ – when a is gift not a ‘gift’

Completely at odds with centuries old equitable principles, pensioners transferring the whole title of their house to their child for no payment with a right of residence for life will constitute a ‘granny flat interest’ without any deemed gifting. The same applies if the parent buys a home in the child’s name or pays the costs of renovations. If the parent does anything more, the ‘more’ will be a gift to which a ‘reasonableness test’ will apply to determine the extent of the gift and reduction of pension. This applies for a five year period from the gifting including if the granny flat interest is terminated within that time for reasons that were foreseeable then.

CGT

Parent and child should be referred to a tax accountant and ATO TR 2006/14 at paragraph 196 which indicates that the child could be exposed to a CGT liability in respect of any payment received for granting a right to reside for life. Arguably, this would also apply to receiving title to the property, or a part interest, for less than current market value.

Conclusion

An elder staying at home or moving to a retirement village with a registered leasehold title may well involve far less legal, financial and family strife than an IFAA. Lawyers retained to draft an IFAA need to exercise great care in addressing the issues of the security and timely retrieval of the parent’s financial contribution, security of tenure and, if applicable, their affect on pension entitlements. 

For self-funded retirees with children not in need of a mortgage, there are still succession issues to be considered. For pensioners, it will be a case of the balancing the retrieval of funds with the diminution of the pension. Given that Centrelink exempt an elder’s reverse mortgage or a loan to a retirement village operator, it seems illogical and unfair to not extend this to intra-family loans for a parent’s care and accommodation with one of their children.

Richard McCullagh BA LLB (Macq)*
22 August 2015

*Adjunct lecturer in Elder Law at the College of Law, Sydney
Legal Director, Patrick McHugh & Co Pty Ltd
Author of ‘Retirement Villages Law in NSW’ Thomson Reuters, 2013

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