It is likely that we will see a federal election called in Australia within the next 12 months, and the Australian Labor Party has proposed some significant changes to the current negative gearing rules. With many myths and headlines floating around, we thought it would be sensible to outline exactly what has been proposed and how this could impact you as a current or future property owner.
Firstly, let’s consider the current negative gearing rules and how they operate for investors.
Negative gearing refers to a scenario whereby the property investor buys an asset that produces a regular income, in the form of rent being received. The interest charged on the loan taken out to buy the property as well as the other costs of owning and maintaining the property exceed the amount of rent being received. This leads to a negative cash flow situation, and this revenue ‘loss’ can be deducted from other Australian income, such as your salary or income generated on other assets. If you’re an Australian expat, these revenue losses can be saved up and accumulate over time for you to utilise at a later date. You can read more about negative gearing for Australian expats in our recent article here.
This can be quite a valuable strategy, particularly given the Australian tax rates are relatively high when compared to other countries such as Singapore or Hong Kong. Deductions on investment property can include both cash and non-cash items such as depreciation of the building costs and also the fixtures and fittings within the property, which can be very useful if you are building a property portfolio.
Let’s look at what Labor is proposing to change in the current gearing rules.
There are two key items that the ALP is looking to change. The first of these is the Capital Gains Tax (CGT) discount that is currently providing to Australian residents on assets held for longer than 12 months. Currently, if you were to buy an investment property, and sell it after 12 months, you could only pay capital gains tax on 50% of the gain, thereby representing a discount of 50%. The proposed change is to reduce this discount to just 25%, representing cutting the current discount by half.
To put this in perspective, let’s consider an example.
John and Pauline have bought an investment property in 2013 in Sydney for $600,000, and are now looking to sell the property at an expected price of $1.3M 5 years after the purchase. Under the current rules, John and Pauline will receive a 50% discount, thereby paying tax on a capital gain of $350,00 (50% of the $700,000 gain). If we assume that they own the property as joint tenants owning 50% each, and have no other income, they would each pay tax of $55,747 on the capital gain of $175,000 each. Under the new rules, they would only receive a 25% discount, and therefore need to pay tax on a total capital gain of $525,000, representing a taxable income of $262,500. The tax liability that both John and Pauline would need to pay under the new rules would be $96,472, a significant jump from the $55,747 they would need to pay under the current rules.
The second key change that the Labor party is looking to implement is the removal of negative gearing benefits on existing properties, while new properties would retain the current negative gearing entitlements. They are not looking to apply this rule change retrospectively, therefore any existing property that you own would be grandfathered and the current rules would apply. This is an important point to note, particularly if you are looking to buy an investment property in the short-term when you’re considering your timing.
It’s also important to note that the current proposed change would be based on your portfolio of existing assets. For example, if a property was generating a loss (i.e. was negatively geared) and another property was generating a gain (i.e. was positively geared), then one could offset the other and wipe out the tax liability. However, the losses being generated could not be used to offset personal exertion income, i.e. your salary, but could be used to offset the tax liability on other investment income. This would appear to make the impact of such a policy change less draconian than many believe, however the truth is that it makes the potential change more complex and requires investors to seek advice and ensure that they’re positioned correctly for such a change.
Let’s consider a simple example to illustrate how this would work.
Sam and Susan are working in Australia, with Sam being employed as a carpenter earning a salary of $120,000 per year, and Susan as a solicitor earning an annual salary of $210,000 per year. They own three investment properties in Australia, two of which are negatively geared and the third is positively geared. The two that are negatively geared are generating an annual loss of $35,000, while the positively geared property generates a positive income of $15,000 per year. Sam and Susan can therefore use $15,000 of their losses to offset the tax liability on the $15,000 positive income each year, however the remaining $20,000 can not be used to offset the tax liability on their salaries under the proposed changes.
Exactly what impact this will have on the broader economy and property market is quite unclear, however it is important that you seek appropriate advice, and in particular ensure that your financing strategy aligns to your overall financial goals under the proposed changes. If you’d like to explore how these changes could impact you, please feel free to contact our team to look at your options.
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