With the Australian Federal Election date set, the 18th May looms close with a change in government looking the most likely outcome. The lead up to an election can prove to be an uncertain time for many. For property investors, the changing of the political party in power can signify a major change to market conditions.
The Labor party holds strong views on some key principles that impact the investment property market, including the below three policies.
Negative Gearing
If voted in, the Labor party will limit negative gearing to only new housing commencing 1st January 2020. All investments made prior to this date will not be affected by the changes and will be fully grandfathered.
What is the aim of this policy?
The aim of this policy reform is to put negative gearing to work by limiting it to new investment properties, which would help boost housing supply and jobs. A Shorten Labor Government aims to improve housing affordability and support housing construction. The grandfathering element of the policy applies to property and assets purchased prior to the start date of their policy.
This means, for example, that if you own a property prior to 1st January 2020, you can continue to negatively gear it after that date. Initially Labor leader Bill Shorten flagged a $32.0b saving to the Australian Federal Budget through savings from negative gearing and capital gains tax cuts (discussed below), but this was heavily criticised with shadow treasurer Chris Bowen coming under fire and facing heavy public scrutiny with the inaccuracy of these figures. Labor initially stated that 96 per cent of current tax incentives were being channelled into existing stock with only 4 per cent into new homes. However, share market-listed Australian Finance Group has provided data showing that 57 per cent of investor loans go to the purchasing of existing homes while only 43 per cent go into new housing stock.
What does this mean for investors?
Ordinarily when the costs associated with holding a property are outweighed by the income it generates through rental yield, the tax loss incurred (or “negative gearing” of the property) allowed you to then offset this amount against other income earned. Should this policy come into play, this would no longer be allowable, limiting the net rental activity to a nil tax position, and then carrying forward the loss to be offset at future date (potentially once the asset is realised/disposed of by way of cost base addition).
According to industry experts, the current opposition’s plan to overhaul negative gearing was based on substantially incorrect analysis of industry data and could trigger a “catastrophic” investment collapse. The thought of removing negative gearing benefits from existing properties and restricting this to only new housing may further reduce the value of existing dwellings compared to new dwellings, but will this also mean the proposed policy will create a tax bias towards investment into new residential property given it will be an asset class with a preferential tax treatment, and lead to the possibility of inflating the price of new residential property.
Capital Gains Tax Discount
Labor has detailed that they will halve the capital gains tax discount for all assets purchased after 1 January 2020. This will reduce the capital gains tax discount from assets held longer than 12 months from 50 per cent to 25 per cent. All investments made prior to the 1 January 2020 will be fully grandfathered.
What is the aim of this policy?
Labor’s policy of halving of capital gains tax concessions for all assets, including property assets, is also expected to affect investor appetite. In an already “volatile” market, the property industry sentiment across the eastern seaboard has fallen for a fourth straight quarter as concerns about the economy have added to those about falling residential markets and pushed a key industry barometer (survey of industry participants) to a six-year low. With the Property Council of Australia highlighting it may be a bad time to be making risky changes to both the negative gearing and CGT tax policies given the fragility seen in the residential housing market and how important this is to the overall economy.
What does this mean for investors?
Ordinarily when an asset is purchased and held ready for use for a period greater than 12 months, for those already eligible owners, a 50 per cent discount was available, halving the taxable valuable by 50 per cent, meaning an effective tax rate of 23.5 per cent for an individual currently in the top marginal tax bracket (rate applies to the disposal of the eligible asset only). Should the proposed policy become legislation, that effective rate for the same individual converts to 35.25 per cent. The grandfathering element of the policy applies to property and assets purchased prior to the start date of the policy (1 January 2020). The changes to the CGT discount will not apply to superannuation funds or to the 50 per cent active asset reduction concession that applies to small businesses.
General Taxation
The lack of negative gearing laws creates a difficult environment to implement proposed changes. If Labor is to achieve their desired tax outcome, they will need to create new definitions and distinctions in the tax laws. Initially, a revised definition of new residential property will be required. A plausible approach could be to adopt the same definition that is used for GST purposes, which captures both newly constructed and substantially renovated properties. However, this current policy lacks clarity surrounding definitions of new and old dwellings, and residential and non-residential.
What does this mean for investors?
On an equity basis, it would be justifiable to grandfather the treatment of existing properties. Taxpayers have acquired these properties through existing tax laws, and should not be penalised for subsequent changes. It is most probable that these proposed law changes/loss of tax benefits will be a priority and factored in as investors within the market assess whether to hold or sell a property. There is the potential that investors will hold property investments that they would have otherwise sold, reducing the supply of properties into the market.
What could this mean?
Arguably the most complex change to implement will be that required to limit the classes of income that negative gearing losses can be offset against. It is not clear cut to say “wage income” that losses cannot be offset against. If the policy is to be fair, it would need to apply to all types of employment type incomes, regardless of form. This would then include income earned by independent contractors. Looking back at Australia’s history of tax laws shows that disputes arise when distinctions are made between different types of income, we can only hope the same mistakes are not repeated.
Policy changes the Labor party are looking to implement may present challenges to investors. These factors should be considered in the lead up the Federal Election. For more information on how the election may impact your investment property or your portfolio, speak to a trusted William Buck advisor.
