With the Federal election due to be called any day now, Labor’s proposal to reform negative gearing and the capital gains tax discount is once again in the political spotlight. As housing affordability begins to improve, a change in government (which could lead to a change in political agendas) is likely to have far-reaching implications for potential buyers, small businesses and the economy.
Before taking a closer look at Labor’s proposed changes, it’s important to understand a few of the basics about the current negative gearing and capital gains tax discount set up.
What is negative gearing?
Gearing is when an investor borrows money to buy an investment, usually a property.
Negative gearing is when the investor loses money on the investment in the short term (i.e. the loan and related costs are greater than rental income) with the expectation of making money, or capital gains, in the future.
The investor is entitled to deduct any losses associated with the investment from their salary or wage income.
For example: Louise buys a house as an investment property and the expenses for the property are greater than its rental income. This results in a $10,000 loss. Louise can use that $10,000 loss to reduce her $150,000 income to $140,000.
What is the capital gains tax discount?
When you sell an asset and make a profit, this profit is considered a capital gain. You then have to pay tax on this gain at your marginal tax rate. If you are an individual or a trust, and have owned the asset for at least one year, you are entitled to a 50% tax discount.
For example: Tom has owned a property for 5 years and when he sells it, he makes a profit of $100,000. His annual salary is $150,000 in the year of sale. Applying the capital gains tax discount would see the capital gain reduced to $50,000.
What are the proposed changes?
In 2016, just prior to the last Federal election, Opposition leader Bill Shorten promised if Labor won the next (now upcoming) election, they would reform negative gearing and the capital gains tax.
“We will put the great Australian dream back within the reach of the working and middle class Australians who have been priced out of the housing market for too long,” Mr Shorten said at the time.
A new Labor government would limit negative gearing to new housing only. You will no longer be able to claim losses from negatively geared properties (except for new housing) but you will be able to offset expenses against related income from your positively geared assets.
Positive gearing is when an investor makes money from an asset and is therefore liable to pay tax on this income at their marginal tax rate.
Capital gains discount
Labor has also promised to halve the current capital gains discount from the current 50% to 25%, providing the asset is owned for longer than 12 months.
Who benefits from negative gearing?
With the election looming and the state of the housing market in the news almost daily, it’s not only important to understand what these proposed changes are, it’s also important to think about who actually benefits from negative gearing and capital gains tax discount.
Some interesting points to consider:
- Almost 1.3 million Australians own a negatively geared investment property.
- More than 50% of negative gearers earn less than $80,000.
- 90% of taxpayers do not use negative gearing.
- The independent Parliamentary Budget Office estimates Labor’s policy will raise about $32.1 billion over a decade.
- In 2015, investors outnumbered owner-occupiers in new housing loans for the first time.
- Negatively geared investors write off their losses in full as they occur, but they are only taxed on 50% of their gains when they sell.
- Almost 70% of capital gains accrue to those with taxable incomes of more than $130,000. These incomes are in the top 10% of income earners.
What do these changes mean for me?
If you are an investor, your existing arrangements will be ‘grandfathered’, meaning you will still be able to negatively gear your current rental properties.
If you are looking to sell your property, while some commentators have expressed concern that these changes may result in the market becoming ‘tepid’ as potential investors shy away without the negative gearing benefits, others note that investors already get a good deal and the changes will affect only a small percentage of taxpayers.
If you are a first home buyer, Labor believes you will be given more opportunity to enter the housing market as more new homes will be built to take advantage of the changes and housing becomes more affordable.
If you are a small business or superannuation fund, Labor has previously indicated that super funds will be excluded from the changes and there will be no changes to the existing small business capital gains tax concessions.
If Labor wins the next federal election and these proposed changes become legislation, there is little doubt this would change the property investment landscape in Australia.
When is all this going to happen?
With the election likely to be called for either May 11 or May 18, 2019, it is unlikely a new Labor government would be able to legislate these changes before the start of the new financial year. Labor has now confirmed that these changes will take effect from 1 January 2020.
So, for now we sit tight and wait and see what the outcome of the upcoming election will be.
If you need advice on negative gearing or capital gains tax, speak to one of our friendly advisors today by contacting us at (08) 9367 8133.