Home owners looking to invest in a rental property without taking on significant debt are finding a solution in their own backyard. The granny flat is regaining popularity as a solution to tight rental markets, an ageing population and metropolitan land shortages, thanks to more relaxed legislation in some parts of Australia.

Whether it’s actually for granny, an adult child or an unrelated tenant, a second residence on your existing property can bring benefits, if you do your homework.

Not just a room for rent

Different states have different rules but generally granny flats:

• Can be built only on residential blocks 450 square metres or larger that are not strata title, subdivided or community title property.

• Must be owned by the same person(s) as the main dwelling.

• Can have no more than 60-70 square metres of living space (patios, verandas or carports can be additional).

• Can be attached to the primary dwelling or freestanding.

• Must have a separate entrance (even if attached to the main house).

Regulations regarding construction and occupancy differ between states and territories, so do your homework before finalising plans. Planning rules can also vary among councils.

Managing up

Having the grandparents close by has all sorts of family advantages, providing everyone gets along! One of the biggest perks, apart from having built-in baby- sitters, can be lightening the financial load for both the senior and junior parties.

Often parents agree to cover the cost of building a granny flat as an affordable alternative for their retirement, while their child can benefit from increased value to their property and possibly a rental income further down the track.

But don’t assume a granny flat will instantly add value above and beyond its cost. Often the value is derived from the opportunity for an extra income to help pay down the mortgage on the primary residence faster. It will depend on the housing market in your area as to whether a second residence adds to the overall value of your property - another reason to do your homework.

It’s also important you get legal advice for your circumstances so if someone dies or has to go into care, or the younger family decides to sell, the financial implications are clear for everyone involved.

Still in the nest

A granny flat can be a win-win for parents whose adult children are still attached to the family home and all of its convenience. The separate residence gives both parties privacy, while the younger generation can get a taste of independent living and save on rent. Parents may have to set some clear boundaries with this option because, although the kids are at arm’s length, they are still under your nose and may still need to abide by your house rules.

Investing close to home

Taking the plunge into investment property can be daunting for home owners. With a granny flat, you can dip a toe without hefty debt and be positively geared from the get-go. For an investment of around $120,000 in a capital city, you are likely to reap $220-$330 a week in rent.

Talk to local real estate agents to gauge the local rental market. Granny flats (either attached or detached) often appeal to single women who appreciate the extra security of someone else living on site or young people studying from out-of-town or overseas, especially if your residence comes fully furnished. You should also research whether a one or two-bedroom residence would be more rentable in your neighbourhood.

Tax implications

Capital gains tax (CGT) doesn’t apply to your main residence, no matter how much it appreciates in value from when you buy to when you sell. You can even rent it out for six years, CGT-free, providing you don’t claim another property as your main residence for that same period.

However, the CGT exemption may no longer apply for part of your property when you add a granny flat, which means you may have to pay CGT when you sell up. The rules can be complex and a little blurry, and hinge around how the granny flat is used, so make sure you get independent, professional tax advice to fully understand the tax implications for your situation.

Need extra money to fund the build?

Talk to your broker if you are considering creating a second residence. It might be a good opportunity to review your home loan and find a deal to better suit your circumstances.