Federal election 2019: Labor’s negative gearing, tax reforms explained

One of the main advantages of holding a negatively geared property is the ability to offset any loss incurred, including depreciation, against the investor’s taxable income. In some cases, the tax savings can exceed the total net loss of the negatively geared property.

By implementing negative gearing as a strategy, the property-related costs are, in essence, paid for by your tenant through rental returns, by the Australian Taxation Office through tax savings and by your own surplus cash flow.

What is capital gains tax?

Capital gains tax (CGT) is the tax that homeowners pay on their capital gains, or the profit made after selling an asset. It is considered part of their income tax. Principal places of residence and inherited and gifted properties are typically exempt from capital gains tax.

Individuals and trusts are entitled to a 50% discount on the capital gain amount if they have held the property for more than 12 months.

The proposals

1. Negative gearing to be limited to new housing starting 1 January 2020

From the determined date, taxpayers can only deduct rental losses against their income if the losses come from newly constructed housing.

Losses from investments can still be offset against investment gains in the same financial year, regardless of asset class. These losses can still be carried forward and offset against future capital gains on the investment

All investments made before 1 January 2020 will not be affected by the changes and will be fully grandfathered.

2. Capital gains discount will be halved for assets purchased after 1 January 2020

Capital gains tax discount for assets held longer than 12 months will be reduced from 50 per cent to 25 per cent.

Investments made by superannuation funds and small business assets will not be affected by the policy change. Further, all investments made before 1 January 2020 will not be affected by the changes and will be fully grandfathered.

Why make changes?

(Disclaimer: All information under this section have been taken from the Australian Labor Party's website)

Through the planned change in negative gearing and tax reforms, Labor aims to help improve housing affordability across Australia, where ‘working and middle class families are increasingly being priced out of the housing market’.

According to them, contrary to the main goal of their implementation, negative gearing and the capital gains discount have not boosted the housing supply. Moreover, they will cost approximately $10 billion from the federal budget – more than the amount dedicated to higher education or child care.

Labor believes that tax subsidies only continue to benefit the wealthiest Australians. On their website, it said that the National Centre For Social And Economic Modelling (NATSEM) found that the top 20 per cent of income earners receive around half of the negative gearing benefits, with the top 10 per cent capturing more than the bottom 60 per cent. Similarly, the top 10 per cent of income earners receive nearly 70 per cent of the total subsidy for the capital gains tax discount.

The Labor Party believes that their policy changes on negative gearing and capital gains tax discount will resolve the unfair advantage over first home buyers.

Finally, Labor aims to support productive investment and, ultimately, support economic growth and jobs growth across the country.

According to them: “The vast bulk of investment does not increase supply or boost jobs. All it does is increase demand and the price of the existing homes, allowing investors to use tax subsidies to outbid owner-occupiers and first-home buyers from existing properties.

“Rather than leading to productive investment, the combination of the capital gains tax discount and negative gearing has led to over-investment in loss making on existing property.”

Overall, Labor, through their tax reform package, aims to establish a sustainable federal budget, make Australia’s tax system ‘fairer’ and encourage the building of new houses to spur jobs growth and increase housing affordability.

Expert insights

Propertyology’s Simon Pressley referred to the proposed changes, particularly on negative gearing, as a ‘complete financial experiment’ that is likely to affect industries beyond the property market.

“It’s something that's been here since Captain Cook hid it when he came here with the first fleet. That’s how long it’s been ingrained into our economic ecosystem.”

“It affects a lot more than property markets directly. It affects welfare, it affects the construction industry, it affects taxes, it affects a whole heap of things. So, anyone who wants to tinker with that, you’re tinkering with big picture Australian economics.”

Economy may be negatively impacted

Over the short term, Property Investment Professionals of Australia (PIPA)’s Peter Koulizos expects to see a slight boom in the property market, right before the changes in policies are implemented.

However, once implemented, it could negatively impact the wealth-creation of average investors or the so-called mum-and-dad investors, who are likely to take the brunt of the changed landscape.

Further, the planned tax reforms may turn out to be counterproductive for improving housing affordability.

According to Mr Koulizos: “It’ll actually be worse for the government so far as the federal budget is concerned, because even though they dish out negative gearing benefits, they collect far more in capital gains tax revenue than they give out in negative gearing benefits, and that's going to be worsened if it’s only focused on brand new property.

“Brand new property attracts greater negative gearing benefits, because it has greater depreciation, but it has less capital growth, so the government will be collecting less in Capital Gains Tax revenue.”

“I know they say they’re going to make housing more affordable, but more affordable is just code for dropping property prices, and I can’t see the sense in the value of Australian property falling all over the country just to assist first home buyers.”

While first home buyers may enjoy affordable housing, they could also face a ‘faltering economy, lower employment prospects, the possibility of higher interest rates’ once the policy changes are implemented, Real Estate Institute of Australia (REIA) president Adrian Kelly said.

The negative impact may also extend as well to homeowners, renters, the construction industry, state governments and the economy.

Rental costs may rise, property prices and housing supply may drop

Statistics from SQM Research showed that, under Labor’s negative gearing policy, rents could rise by up to 15 per cent while property prices could collapse by a further 12 per cent by 2022.

In contrast, under projected conditions without the changes, price growth could be relatively strong over the same period while rental growth could be more subdued.

“While their grandfathering provisions are intended to encourage investors to retain their existing investment properties, decisions about new investments in residential housing will be strongly influenced by the higher taxation grab on investment returns and uncertainty about subsequent sales of new properties and future tax changes,” Housing Industry Association’s Graham Wolfe said.

Moreover, under Labor’s negative gearing policy, the number of new homes may drop by up to 42,000, creating an $11.8 billion hit to the economy.

According to Master Builders Australia’s Denita Wawn: “We need all incentives for investment on the table rather than taking away incentives from one part of the market to prop up another. This is just robbing Peter to pay Paul.”

Of the capital cities, only Darwin may not see growth in rents and yields should the new negative gearing policy push through.

On the other hand, property prices are expected to decline in most capital cities between 2020 to 2022 due to ‘rapid decline in investor demand’, with Melbourne and Sydney experiencing the worst results. Perth, Adelaide and Hobart, meanwhile, may see growth between two to 10 per cent.

Investment activity may decline

In a survey conducted by the Property Council of Australia, 49 per cent of investors said that they would leave the market should the changes be implemented – a direct challenge to Labor’s assumption that their tax reform package will improve the overall state of the property market, particularly the new housing supply and construction.

With housing market conditions already in sharp decline due to the tightening credit conditions and the softening of major markets such as Sydney and Melbourne, this could be the worst time to be discouraging property investment further.

Ms Wawn said: “Labor conceived this policy in booming housing market — this is no longer the case. House prices have fallen by at least 15 per cent in Sydney, Melbourne and Perth, while new dwelling approvals and lending volumes are driving lower at some pace.”

“Investors will be less likely to invest in newly-constructed housing under the ALP’s tax changes, not more likely. This is a critical new insight, because if less new housing is being created for people to rent it can only mean higher rents in the medium term,” Property Council of Australia’s Ken Morrison added.

Overall, tinkering with even a single part of the tax system would be risky and may ultimately impact average Australians the most.

According to Real Estate Institute of Western Australia (REIWA)’s Damian Collins: “These report results are not entirely hypothetical either. In the 1980s, when negative gearing was removed, these were the consequences experienced at that time in Western Australia. The impact was so great across the country that negative gearing was reintroduced just two years after it was removed.

“We must learn from history. Removing or meddling with one part of the tax system is irresponsible. Any changes to our tax system should be done holistically and include a full review of our entire tax system.” 

Of the capital cities, only Darwin may not see growth in rents and yields should the new negative gearing policy push through.

On the other hand, property prices are expected to decline in most capital cities between 2020 to 2022 due to ‘rapid decline in investor demand’, with Melbourne and Sydney experiencing the worst results. Perth, Adelaide and Hobart, meanwhile, may see growth between two to 10 per cent.

Business as usual

Propertyology’s Simon Pressley said that the influence of the changes may not be as colossal as most people are lead to believe.

According to him: “Tax policy is nowhere near the biggest influencing force over the property market.”

“Now, those who think it is and want to sit on the sidelines, you’re only going to harm yourself. If you don’t invest because you don’t get the election outcome you want and negative gearing gets scrapped, well, how’s that going to help you in retirement?”

Further, despite the tax benefits, he strongly advised against investing in property for the sole purpose of negative gearing because, at the end of the day, ‘if you’re negative gearing, you’ve lost money’.

Instead, he encouraged investors to look at negative gearing like any other tax policy, including stamp duty and land tax.

“Buyer behavior, positive or negative, is what creates price fluctuations. Only 60 per cent of the investment properties in this country are negatively geared. There are only a small percentage of buyers who are affected by it.”

While Mr Pressley, like most of his colleagues, is not in favour of the policy changes on negative gearing, he reminded investors that life will go on and the market will continue to run whether or not they are implemented.

“Sometimes in life, we just have to suck up – it is what it is – and get on with it,” he said.

How investors can prepare

While there is still a lot of uncertainty regarding the future of the market prior to the federal elections, experts strongly advise investors to reassess their strategies and consult property tax professionals, where appropriate, in order to prepare themselves for any major changes in the property market moving forward.

Including the changes in negative gearing and capital gains tax discount, there could be up to 13 major policy changes to be implemented should there be a change in government this year, according to the Institute of Public Accountants’ Tony Greco.

Naturally, a shift in major policies could have significant impact on the growth of portfolios across the country. Add the current fluctuations in major markets such as Sydney and Melbourne and investors may have to change how they operate across the property market.

“It’s not well understood that these changes do not just relate to property. It relates to all investments. If you’ve borrowed money against shares or borrowed money against managed funds, it’s going to be the same deal with property. There’s a lot at stake,” Mr Greco said.

Thus, he encouraged investors to reassess their portfolio and their financial position in order to prepare themselves for any major change in the property investment landscape and, in the same way, continue to thrive despite fluctuations in the market.

According to Mr Greco: “Look at all your properties—is there an excess amount of deduction that could be offset? If you have a property that’s positively geared and one that's negatively geared, you pull them together and see what the overall impact could be. That's how we envisage the policy to operate. It will be different for every property investor, especially if they have a mix of positive and negative investments.”

“From a cash flow perspective, nothing changes, but if you had to realise that property in the short term, you have to factor in some adjustment in the market price. I think for anyone who’s contemplating a transaction in the foreseeable future, I think that’s got to be on the radar.”

“On the other hand, someone who wants to purchase another property and use negative gearing as a strategy will have to recognise that it may not be available for an existing property.”

He also advised investors to get in touch with professionals, where appropriate, to get a better understanding of the possible impact of the proposed changes.

“Understanding how these possible changes can impact the broader market is a good starting point. Accountants will be well-versed enough to explain these to you, while taking into account your future ideas about how to operate your portfolio. Have a conversation with your trusted advisor as early as now.”

However, do not go rushing around to change strategy, according to Rethink Investing’s Scott O’Neill, because, at the end of the day, nothing has been set in stone just yet.

Mr O’Neill reminded investors that making big investment decisions off the current speculations could do more harm than good, regardless of the election turnout.

““Do you need to quickly hurry up and change your tactic around investing in property? No, because you never go make a decision off the bat.”

“Right now, we don’t know who’s actually going to be in power. There’s strong opinions, of course, but you don'’t get to make a big investment decision off these speculations. You just need to wait it out and see what happens,” he said.

Moving forward, Mr O’Neill advised investors to continue investing on the basis of property growth fundamentals –that is, supply and demand, infrastructure, population growth, jobs growth and overall local and national economy.

After all, there will always be opportunities in the market despite softening markets and policy changes, as long as investors stick to long-term strategies that are based on their personal goals, capabilities and limitations.

“If you look back at all the crashes in history, there’s been almost triple or quadruple the growth before the correction. So buy for the long-term, make sure you’ve got the cash flow to support yourself and just pick good markets.”