Capital-gain move could hit hard
The ongoing tax reform debate has created new difficulties for making medium-and long-term investment decisions. If elected this year, Labor will from July 1, 2017, limit access to negative gearing tax deductions to purchases of newly constructed properties and substantially increase capital gains tax liability on assets acquired after that date.
This announcement provides a financial incentive to finalise any proposed investment-property purchase before the end of this year to avoid losing valuable personal tax benefits. But there's now a real risk that future property investment returns could be adversely affected if these changes are implemented. In making investment decisions, even though reducing tax bills is a key factor, even more important is achieving a positive after-tax return.
A substantial capital gain is required to compensate for ongoing negative annual income returns and the annual costs of servicing the loan.
The property industry is predicting dire consequences from changes to negative-gearing arrangements. This would certainly be the result if existing geared transactions were to be affected but Labor has no intention to alter these. Similarly, the Coalition is most unlikely to make changes adversely affecting existing investors.
By continuing to allow negative gearing for newly constructed homes, the Labor plan will still encourage investor demand for new property while reducing investor demand for existing premises. This will help first-home buyers and other owner-occupiers compete in the property market and reduce the upward pressure on prices.
The property industry claims that reduced investor demand will lead to falling property prices. This ignores the fact that existing investors will be less willing to sell because of the substantially higher capital gains tax payable on replacement new investments after July 1, 2017.
Newly built properties offer much larger tax deductions for depreciation and associated costs than existing properties, which will partly compensate for the inability to negatively gear purchases of existing properties.
Overall, however, the capital gains tax increase will be the most important determinant of the change in the supply of housing available for rental. The higher capital gains tax on new investments will increase the demand for and investment in the tax-exempt family home and reduce future investor demand.
Because capital gains tax is payable only when properties are sold, when gains are realised many of them are likely to be large and subject to higher marginal tax rates.
Labor's proposal increases the maximum capital gains tax rate from 24.5 to 36.7 per cent. This tax increase is likely to unsettle property markets more than the negative-gearing changes because of its impact on all future property investments, whether geared or not.