The breakdown: Labor’s Property Policy. Housing policy is certainly a contentious issue amongst Australians. With the 2016 election result still unknown (at time of writing) but with the likelihood of Labor eventually getting in to power in the next few years (this is how it usually works right!) I thought it would be useful to properly explore their policies to understand how they may affect you as an investor or a prospective investor.
Put simply negative gearing means an investment asset incurs greater expenses than the income it generates. With the current system, if an investment asset is negatively geared an investor can reduce his or her taxable income by the amount of the losses incurred while holding the asset. The types of expenses that can be claimed to reduce income and thus taxable income must be specifically related to the acquisition and maintenance of an income producing asset. For property investors the main deductions are typically loan interest, depreciation, council rates, managing agent fees, maintenance and strata fees if applicable.
Labor’s policy looks to make reforms to this. From July 1st 2017 Labor will limit negative gearing tax benefits to only newly constructed properties. This policy will be grandfathered so that those who have or will purchase a property before the end date can still benefit from the current negative gearing scheme. Labor’s plan won’t mean you can offset rental costs against rental income just that any net rental loss won’t be able to be offset against your PAYG or self-employed income.
Losses from property investments can still be used to offset other investment gains.
Net rental losses can also be carried forward to offset the final capital gain on the investment. So for example if you were to lose $5000 on an investment for five years and then after that sell with a capital gain of $80,000, this loss has been carried for the five years and $55,000 of the capital gain is considered when applying capital gains tax.
Capital Gains Tax
Capital gains Tax is the process of paying tax on the money earned from selling an investment property for more than you bought it for. When capital gains tax was first introduced in 1985, assets held for 1 year or more would be indexed by the consumer price index (CPI) before calculating capital gain. This was so inflation would not be taxed. This process was deemed overly complicated so in 1999 the Howard government discontinued indexation introducing a 50% discount on the capital gain for individual taxpayers.
Currently the system works as follows. If you make a gain of $100,000 when selling a property that has been held for more than 12 months this gain is halved to $50,000 and this is added to owner’s taxable income in the year of the asset disposal. If the asset is jointly owned the $50,000 is split based on ownership percentages. In a husband and wife scenario this would usually be 50/50 so $25,000 each would be added to their taxable incomes each. Assuming a marginal tax rate of 0.42 cents in the $ the true amount of tax paid would be $10,500 each.
Labor’s policy reduces the discount on capital gains tax to 25% of the capital gain. Again this will be grandfathered and investments made before the date will not be affected.
I don’t believe Labor's policy if ever enacted will be too much of a deterrent to buying property for investment and won’t affect the market too much. My one caveat is unless of course there is a negative sentiment feedback loop which creates a confidence crisis.
If investors are patient and are able to carry the cost of making a loss on a property for the first few years until the property is neutrally / positively geared then they will do well as always. Short term speculation wont work as well as it has in the past.
There are 2 parts of the policy that I really don't like.
1) The exemption on neg gearing for newly built property. This could potentially cause a distortion in the market for new property and lenders will be less keen on lending on new property (they don't like it much already). So while the policy has good intentions this is the part that I think would fail the most and may leave uneducated purchasers with dud investments that lose value as soon as they buy them. After all the next buyer won't be able to negatively gear the property.
2) The capital gains discount. Howard and Costello's simplification to a % discount has always been flawed but I fear Labors policy is a step in wrong direction. Capital gains should only be payable on gains made above inflation. It is simply unfair to tax inflation yet this is what only a 25% discount will do. Yes it may be more complicated to use an indexation system but is the only fair way to do it.