Prepare for changes to negative gearing and capital gains tax
Whether the federal Treasury's analysis that removing negative gearing tax advantages would have a minimal impact on property prices is correct or not, property investors need to prepare for major tax changes. Changes to both negative gearing and capital gains tax arrangements are now much more likely.
The severity of the impact on real estate investors depends on how market sensitive the changes are. The worst case would be if the changes were to apply to both existing and new investors when interest rates are rising and property prices are stagnant or falling.
To date, income tax and capital gains tax changes haven't been retrospective and existing investors have been protected from the impact of changes. For instance, capital gains tax on all assets purchased before 19 September 1985 are exempt from capital gains tax and only assets purchased after that date are subject to the current tax provisions.
In theory, a future government wanting to maximise revenue and encourage the disposal of assets could apply the new tax provisions to all capital gains accruing after the date of the change. In technical terms, that wouldn't be a retrospective change but it would pose difficulties for the Tax Office and investors.
Given the problems of valuing all assets, especially property, at a given date, the only feasible Tax Office option would be to determine the tax liability on the period of ownership before and after the change. Any attempt to do this would be highly unpopular with investors, especially if the new tax rules severely increased the tax burden.
Any changes are therefore likely to apply only to new investors and impact only on future demand for property. Current investors retaining their tax advantages will only be affected if the changes adversely impact on the future returns on their investments.
While exempting investors in newly constructed property from the negative gearing tax changes as proposed by Labor would favour high level gearing of new houses, the resulting benefits wouldn't necessarily offset the negative impact of the proposed 50 per cent increase in capital gains tax liabilities when assets are sold.
Receiving capital gains, in many cases over an extended period, forms a significant proportion of the returns from ownership of property. Without substantial capital gains to compensate for the accumulated after-tax losses, the attractions of property investments are greatly reduced.
The clear message is that the impact of negative gearing and capital tax changes could have a negative effect on the incentive to purchase both new and existing properties. Indeed, given the importance of capital gains in geared property returns, how new investors respond to a 50 per cent increase in capital gains tax will be crucial to the impact on property prices.