Assessing Labor's negative gearing and CGT proposals

Despite the malaise of the current Liberal Party, we have a growing economy, low unemployment, strong business sentiment and a budget surplus expected to be delivered by the Morrison government in his pre-election budget.

Yet a change in government is most likely to prevail and with that a policy agenda that could have far-reaching impacts on clients, small businesses and the economy.

Negative gearing

Negative gearing is where investment-related expenses (for example in property the cost of maintaining the property, the allowable deprecation and the interest payments) exceed revenue (the rental income). The loss is then claimed as a tax deduction against other income.

While the primary beneficiaries of negative gearing are property investors – mostly everyday Australians, with ATO data suggesting the taxable income of 67 per cent of negative gearers is less than $80,0000 – it can also be argued that it benefits the entire property market through an increased supply of rental properties, which keeps a lid on rental prices.

Proposed changes

Labor proposes to limit negative gearing concessions to newly constructed properties while “grandfathering” existing arrangements, where existing investors and super fund holders will still be able to negatively gear their current rental properties. The stated intention being to level the playing field for first home buyers competing with investors, improve housing affordability and strengthen the Commonwealth budget position, with the Grattan Institute taking the view that negative gearing “costs” the Commonwealth government $4 billion a year.

They agitate that in practice, removing negative gearing on existing properties will lead to lower prices and benefit those buying already-established properties, most likely first home buyers, as investors turn their eye to new constructions and off-the-plan properties. This will in turn broaden housing supply. The increase in owner-occupiers will mean fewer people will need to rent – offsetting potential rental increases on properties that can no longer be negatively geared. Rental increases, they submit, would be mitigated by new rental stock through new constructions, which can be negatively geared.

Potential impacts

Investors

Under these changes, investors who have worked hard to save and enter the property market to build long-term wealth for their family, some of these retirees looking to downsize and sell their investment property, face the prospect of trying to sell these properties to tepid investors without the negative gearing benefits.

In an environment where investors are currently facing softening markets and tighter credit conditions, there is a real risk the potential tax changes will impact investors with current investments, particularly those with large debts and a devalued asset.

In the short term, prior to the cut-off date there may be an increased demand to buy these established properties with the grandfathered provisions, however once the policy is in place there is a real risk these property values will take a major hit.

Another issue is investors who need to sell their properties before they are fully paid off, currently sold with the benefit of negative gearing concessions. They may have interest-only facilities and find themselves in a situation where they are offered prices below outstanding mortgages, while others looking to sell as part of their retirement planning may well be offered prices below what they had provisioned for retirement.

On the other hand, with investors driven to buy new properties, we could see prices on new developments and off-the-plan properties spike as competition increases for newly-built housing.

Alternatively, investors may look to put their money in other asset classes – with ramifications for renters if the stock of rental properties in fact falls.

Against this backdrop an unknown in this is the reaction of credit providers – and whether they require higher deposits for investors to manage their risk.

Renters and home buyers

A real issue for renters may be that the cost to rent properties that can no longer be negatively geared may increase to help cover the investor costs. Additionally, it is debatable this policy will shift renters immediately into buyers, and that stock from new construction projects will deliver immediate benefits.

With future construction most likely in areas zoned for higher density construction – this will not be suitable for all renters and their families and is reliant upon planning and zoning decisions by state and local governments.

However, for every investor taken out of the market for established housing, the path may well become easier for an owner-occupier, and as they purchase, the demand for rentals will fall. With investors limited to new housing stock, this introduces new rental stock to the market rather than trading existing rental stock between investors.

CGT changes

Labor has also proposed to reduce the capital gains tax concession for property investors. Currently, individuals and trusts are entitled to a 50 per cent discount on the capital gain providing they have held the asset for more than one year. This discount would fall to 25 per cent. Again, grandfathering arrangements would be put in place for existing investors, including investments made by superannuation funds and assets of small business owners.

This is for general information purposes only and does not constitute advice. With all of these options there are a number of considerations outside the scope of what is covered in this article that you need to understand to ensure your personal circumstances are taken into consideration.

Anthony Landahl, managing director and senior finance broker, Equilibria Finance

Adrian Flores

Adrian Flores is a deputy editor at Momentum Media, focusing mainly on banking, wealth management and financial services. He has also written for Public Accountant, Accountants Daily and The CEO Magazine.

You can contact him on [email protected].