Housing is set to take centre stage in this year’s federal budget, and investors are bracing for a major shakeup that could reshape the property market.
While the full details of the federal budget will be revealed on Tuesday night next week, several pre-budget teasers have trickled out over the past few weeks, several of which are focused on the property market.
Big tax changes could have major ramifications for property investors, with a potential overhaul of both negative gearing and the capital gains tax discount likely to feature in the budget.
Will negative gearing be abolished?
Negative gearing is when an investor borrows money to buy a rental property and the expenses of owning the property, including interest on the loan, outweigh the rental income, resulting in a loss.
Under current rules, investors can deduct that loss from other income, such as wages.
While Prime Minister Anthony Albanese repeatedly ruled out changes to negative gearing prior to last year’s election, and Labor’s 2019 election campaign to limit negative gearing was decisively rejected by voters, the controversial policy is back on the table this year.
Both Mr Albanese and treasurer Jim Chalmers have remained tight-lipped on whether negative gearing will be abolished as part of the budget, but their refusal to deny ongoing speculation despite multiple opportunities to do so suggests changes are coming.
Negative gearing and capital gains tax changes are widely speculated to be a feature of this year's budget, although treasurer Jim Chalmers said people will need to wait until Tuesday night for the big reveal. Picture: Martin Ollman
Dr Chalmers has flagged “intergenerational unfairness in the tax system and in the housing market” and stated that one of the government’s motivations in the budget is to make it easier for people to get into the housing market.
Negative gearing has long been contentious, with some arguing it disproportionately benefits wealthier people and drives up property property prices, while reducing tax revenue which could otherwise be used on services to benefit the broader community.
Proponents of negative gearing argue it supports investment into the housing market by compensating investors for losses incurred by making properties available for rent.
Ideas reportedly on the table for phasing out the policy include limiting negative gearing to just one property, or ending negative gearing for existing homes while allowing investors to claim the loss deduction for new dwellings only.
New homes could potentially be excluded from any changes to negative gearing in a move that could encourage more housing construction. Picture: Getty
The aim would be to ease investor demand for existing properties to help first-home buyers get into the market, while incentivising investors to buy new properties, which would encourage more housing construction.
However, property industry leaders have warned that restricting negative gearing and the CGT discount could lead to slower rates of home building and higher rents, arguing the focus should be on reducing regulatory barriers to increasing supply before changing tax settings.
Will the capital gains tax discount be reduced?
Investors have to pay capital gains tax (CGT) when selling assets, such as investment properties or shares.
The capital gain is the difference between the purchase and the sale price of the property, minus purchase costs such as stamp duty and selling costs such as agent fees.
The capital gain is taxed at the owner’s marginal tax rate, and main residences are generally exempt from capital gains tax.
Under current rules, investors who hold a property for more than 12 months are eligible for a 50% discount, meaning tax is only paid on half of the gain.
However, this discount is tipped to be axed in this year’s budget, with capital gains tax potentially reverting to an older system used until 1999, known as the inflation indexation method.
This year's federal budget is likely to be one of the most significant in decades for Australia’s property market. Picture: Getty
Under this model, the cost of purchasing an asset would be adjusted for inflation when calculating capital gains tax, based on the movement of the consumer price index between when the asset was bought and sold. Property investors would only pay tax on the amount that the property grows in value above the rate of inflation.
For example, if an investor purchased a property for $500,000, including purchase costs, and sold it for $700,000, including selling costs, and inflation was 10% during the period they held the property, the investor’s cost base would be $550,000 ($500,000 x 10% inflation), meaning they would have to pay tax on a $150,000 gain.
Would new rules apply to existing investors?
It’s likely that investors who purchased properties under the existing system would be able to use the old rules, to an extent – an approach known as ‘grandfathering’.
Any negative gearing changes are expected to be grandfathered, meaning investors who purchased properties before the changes come into effect could potentially continue to deduct rental losses from other income.
If the government abolishes negative gearing altogether or limits it to just one property, that would apply to investors who purchase properties after the changes come into effect, which is likely to be either budget night on May 12, or the start of the new financial year on July 1.
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For capital gains tax, a hybrid approach could allow investors to claim the 50% discount up until the date the changes come into effect. Capital gains from that date onwards would then be taxed under the inflation indexation method.
The different CGT models are likely to be apportioned based on the length of ownership. For example, if an investor bought a property five years before the changes came into effect, and sold it five years after, they could claim the 50% CGT discount on half their gains, and the indexation method on the other half.
The full picture will be revealed on Tuesday night, but if even some of the mooted changes materialise, this budget could mark one of the most significant turning points for Australia’s property market in decades.
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