Why property investors won't take their profits
While the boom in property prices has increased the risks for new property investors, many existing investors, particularly those who are negatively geared, face the prospect of considerable capital gains tax bills if they take their profits. Even though only 50 per cent of profits is subject to capital gains tax for assets owned for longer than 12 months, the potential tax liability can be as high as 24.5 per cent of the gain.
This tax rate can be reduced by selling at a time when other taxable income is low, for example after retirement. However, for assets with substantial gains attached, the capital gains tax payable when the property is sold can exceed the potential loss if property prices fall.
These tax considerations help explain the reluctance of many successful investors to take their profits. Nevertheless, the attractions of gearing are reduced in retirement when positive cash flow is needed to maintain living standards. Achieving this result requires either the repayment of debt or the sale of assets to reinvest in income-generating investments.
While tax liabilities are high during working life, repaying investment debt will increase taxable investment income and increase tax bills. However, provided access to savings is not required before retirement, making super contributions is a tax-effective alternative to paying off investment debts.
There are two options to boost super account balances: tax deductible employer or self-employed contributions and non-deductible non-concessional contributions to a fund. The July 1, 2017, changes reduce the deductible contributions allowed to $25,000 annually but non-deductible annual contributions of up to $100,000 are still possible.
Even though non-concessional contributions don't generate an immediate tax saving, the benefit is the accumulation of assets in a tax-favoured structure where the maximum income tax payable is 15 per cent. Compared with paying off an investment loan, which increases personal tax bills at marginal rates as high as 49 per cent on the reduced interest cost, this is an attractive way to accumulate retirement assets.
At retirement, when personal income tax payable is much lower, the superannuation assets can be withdrawn tax-free after age 60 and used to reduce investment debt. This will increase the cash flow from the investment to help fund retirement.
Alternatively, the asset can be sold paying the relevant capital gains tax liability and the net proceeds invested subject to the $1.6 million cap in super or elsewhere. At this time, capital gains tax liability will be lower than if the asset were sold during working life.
The clear message is that building up super account balances has attractions compared to paying off investment debts, particularly for middle-aged or older taxpayers.