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Granny flats, tax and Centrelink

From Modular Living Australia — the independent knowledge base Last updated: 12 Oct 2026

From 1 July 2021, capital gains tax does not apply when a formal granny flat arrangement is created, varied or terminated.^[1] Renting out part of your home removes the full main residence exemption, although a partial exemption may apply, and Centrelink assesses rent from a property as gross income minus allowable deductions, disallowing some deductions the ATO permits.^[2][4][5]

The tax and social security treatment of a secondary dwelling turns almost entirely on one question: whether money changes hands, and on what basis. A relative living rent-free, a formal life-occupancy agreement, a family member paying something toward costs, and a tenant paying market rent are four different arrangements with four different outcomes across two systems that do not use the same definitions or allow the same deductions. This guide sets out the distinctions that matter. It is not advice, and the amounts involved are usually large enough to justify paying a registered tax agent.

"Granny flat" means two different things §

In everyday use it means a building. In the tax and social security systems it usually means an arrangement — a legal right to occupy — which may or may not involve a separate building at all.

A granny flat arrangement, in the Australian Taxation Office's sense, is a written agreement giving an individual the right to occupy a property for life^[1]. The interest can be in part or all of a property, and the property can be the owner's main residence or a separate one. The physical granny flat in someone's backyard may be the subject of such an arrangement, or it may simply be a rented flat, or it may be occupied by a family member with no formal agreement at all.

Getting the category right is the first step, because everything below follows from it.

The CGT exemption for granny flat arrangements §

From 1 July 2021, capital gains tax does not apply when a granny flat arrangement is created, varied or terminated^[1].

The conditions are specific. The owners and the individual holding the granny flat interest must enter into a written and binding arrangement, and that arrangement must not be commercial in nature. The individual holding the interest must meet the eligibility requirements. And the exemption applies only to the creation, variation or termination of the arrangement — other CGT events that sit outside it remain subject to normal CGT rules^[1].

Two consequences are worth stating plainly.

The first is that the exemption does not extend to the eventual sale of the property. A later disposal of a property that was used in a granny flat arrangement is governed by the ordinary rules^[1]. The exemption removes a tax event at the point the family arrangement is set up; it does not shelter the house.

The second is that the arrangement must not be commercial. Where the occupant pays market rent, the arrangement is not a granny flat arrangement in this sense, and the analysis moves to the next section.

The ATO also states that creating, varying or terminating a granny flat arrangement does not affect the main residence exemption^[1].

Renting it out changes the main residence exemption §

An Australian resident's main residence is generally exempt from CGT. That full exemption is not available where part of the home is rented out or used to run a business, though a partial main residence exemption may apply. On sale, the part used to earn assessable income is subject to CGT — and income tax deductions can usually be claimed for the part of the home used to produce that income^[2].

This is the trade-off that most granny flat investment material omits. Deductions during ownership and a CGT liability on sale are two sides of the same fact: once part of the property produces assessable income, that part is no longer fully sheltered by the main residence exemption.

Whether a detached secondary dwelling on the same title is treated as "part of your home" for this purpose, and how the apportionment is calculated, depends on the facts and is not something this site can resolve for a particular property. It is precisely the question to put to a tax agent before the first tenant moves in, not in the year of sale.

Centrelink treats occupants in two ways §

Services Australia does not use the tax categories. The relevant distinction for payments is between a boarder or lodger and a tenant of a property you own.

For boarders and lodgers, only part of what they pay counts as income, with the amount depending on whether meals are included; where the arrangement costs more than the allowed expense amount, less income may be counted, and the costs can be evidenced from the tax return. In some circumstances the income is instead treated as self-employment income — for example where rooms are rented as part of a business. Income from accommodation at another property the person owns is reported as rental income rather than under the boarder and lodger provisions^[3].

For rent from a property you own, the lease or rent money counts in the income test, assessed as gross income minus allowable deductions^[4].

Which category a backyard secondary dwelling falls into is a determination for Services Australia on the facts of the arrangement, and this guide does not attempt to predict it. Where a payment is involved, it is the question to resolve with Services Australia before the arrangement starts rather than after an overpayment notice.

One threshold is worth knowing: where a homeowner rents more than five rooms, the arrangement is assessed as a business operation rather than under the boarder and lodger provisions^[5].

The granny flat interest and the assets test §

A granny flat interest is an agreement for accommodation for life. It can affect eligibility or rate of payment and may be included in the assets test. Services Australia may also assess a person's principal home as a granny flat interest where assets or money have been transferred in order to live in a property owned by someone else^[6].

That second limb is the one that catches families. A parent who contributes to the cost of building a granny flat on a child's property, or who transfers a home in exchange for a right to live there, has done something with social security consequences even though no rent is paid and no tax event may have occurred. The detail of how that is assessed is covered in Granny flat interests and the age pension.

Centrelink deductions are narrower than tax deductions §

This is the trap that produces unexpected results, and it is not widely understood.

Deductions that are allowable for tax purposes but not for social security include capital depreciation, special building write-off, construction costs and borrowing costs^[5].

A newly built secondary dwelling is exactly the case where those disallowed items are largest. The consequence is that the same dwelling can produce a loss for tax purposes — because depreciation and building write-off are deductible — while producing assessable income for Centrelink, because they are not. An owner who assumes the two systems will reach the same answer can find a payment reduced despite a tax return showing no profit.

Two further points on the Centrelink side: where a property runs at a loss, Centrelink treats the income as zero rather than allowing the loss to offset other income, and losses on one property cannot be offset against income from another^[7]. Personally held investment property is included in the assets test but deeming does not apply to it — Services Australia looks at the actual rent less allowable deductions^[7]. A capital gain on selling a property does not count as income for Age Pension purposes^[7].

What is not covered here §

Land tax is not covered by the sources compiled for this guide. It is a state and territory tax, the principal place of residence exemption operates differently in each jurisdiction, and the effect of a rented secondary dwelling on that exemption is a question for the relevant state revenue office or a tax agent. Nothing on this page should be read as suggesting land tax is unaffected.

Also not covered: stamp duty and other state duties; GST; the tax position of a granny flat built by a company or trust; negative gearing outcomes; depreciation schedules and their preparation; and the treatment of payments under any specific Centrelink payment type other than as described above. Rates, thresholds and indexed figures are deliberately omitted throughout — they change, and the ATO and Services Australia publish the current ones.

The changes to negative gearing and to the CGT discount legislated in 2026 are set out in the 2026 negative gearing and CGT reform.

References §