Last night, we saw some significant proposed changes to taxes that affect property investment in Australia. While some of the changes will require legislation to be passed by the House of Representatives and the Senate, given the numbers in Parliament held by Labor and the Greens, there’s little doubt that these reforms will be implemented in some shape or form.
I’m sure you will see plenty of headlines in the coming days, so I wanted to share exactly what our experts believe these changes may mean for you.
To begin – it’s certainly not the time to make any rash decisions. As the changes are not retrospective, and the proposed changes to capital gains tax don’t take effect until 1 July 2027, there are no impacts in the short term for existing investors. We may see public backlash lead to amendments, which lessen the impact, however, right now, life goes on, rents are paid and returns are made. In fact, residential rents will almost certainly go up at a higher rate than they otherwise would be due to these changes, which is something that will help to alleviate the tax impacts for both established and new investors.
Based on what was proposed in the budget at this time, we’ve outlined the changes and the impact on existing and new investors. We will continue to follow the budget developments closely and update you on any reforms or changes that may shift over time.
What the Capital Gains Tax (CGT) changes mean for property investors
The 50% Capital Gains Tax discount will be removed for all assets from 1 July 2027 and replaced with an indexed, inflation-adjusted method, alongside a minimum 30 per cent tax rate on capital gains after indexation for individual investors.
Investors in new builds can choose between the existing 50% CGT discount and the new indexed method.
A minimum capital gains tax rate of 30 per cent (after indexation) will also be applied to individuals and family trusts on gains from 1 July 2027. There are no proposed changes to investments held in superannuation funds.
The first thing to understand is that CGT only bites when you sell. If you’re a long-term investor with no intention of exiting your portfolio or funds soon, the immediate impact is more limited than the headlines suggest. We believe most of our Momentum and Westbridge investors align with our long-term hold approach to investing, which has seen great results over more than 20 years.
Replacing the 50% discount with inflation indexing for individuals and trusts will impact investments differently, depending on your asset’s growth rate. A lower growth asset may in fact be taxed less with indexation. A property growing at 6 per cent per annum against 3 per cent inflation puts you in roughly the same position as the current 50 per cent discount, at least in the short term.
Over 10 years, it’s slightly less beneficial. Let’s look at an example. Take an $800,000 property and assume 3% annual inflation over 10 years. Your cost base would index to $1,075,133. If the property grew in value by 6% per annum the value would be $1,432,678. Putting aside purchase and sales costs, you would pay the full marginal tax rate on the difference between the two of $357,545, which at the top rate of 47% would be $168,046.
Under the previous policy of a 50% exclusion, you’d pay full marginal tax rates on $316,339, which at the top rate of 47% is $148,679. So, the outcome is roughly an additional $19,500 in tax when you sell, or another 3% of the total gain of $632,678. Over the time of the investment, it’s certainly not as a significant number as many proposed. As always, it’s important to remember that you don’t pay tax unless, and until, you sell.
Where it stings more is on high-growth assets, and that’s no accident. It’s a feature of the policy that effectively penalises good asset selection and risk taking. But let’s keep it in perspective. A capital gain, even a taxed one, is still a capital gain. The fundamentals of long-term property investment don’t change overnight because of a tax adjustment.
Interestingly there were no changes to the capital gains tax arrangements for superannuation funds. That means if you are investing in property through superannuation, it seems that capital gains tax is treated as it was before the budget, which is a 1/3 reduction in the gain, with no indexation. This may increase the appeal of property investing through superannuation.
Pro-rata CGT for existing investors
The budget announcement said that all assets, even those currently owned, will be brought into the new indexation system, but pro-rated based on the time held. It seems you can use a valuation model or a pro-rata model to determine the “value” under the new system. How this impacts each investment becomes more nuanced, as the outcome will depend on several variables including the growth rate on your property before the changes come into play and the future growth rate. Given CGT is only payable when you sell, it shouldn’t be a reason to sell your investment now. If you are currently negatively gearing your property, a benefit that won’t be there for the next established residential investment, selling probably doesn’t make sense.
Negative gearing
From 1 July 2027, negative gearing will be limited to new builds while owners of investments held prior to the budget announcement will still be able to negatively gear their investments in a grandfathered approach.
Investors who buy established properties after last night’s announcement can still deduct losses against residential property income and carry forward any unused losses to future years. However, they can no longer deduct those losses against other income.
Restricting negative gearing hurts short-term cash flow for investors. But investment decisions aren’t made on cash flow alone. They’re made on total return. Savvy investors will adapt. It’s also important to note that the losses aren’t “lost”. You carry them forward until your property is positively geared or you have other passive income. So, it’s deferred benefits rather than lost benefits.
The most likely consequence of this change? Rents go up. If investors can no longer offset losses against income, they will price that cost into what they charge tenants. The burden doesn’t disappear. It shifts. And it shifts onto the people this policy is supposedly designed to help.
When negative gearing was abolished in 1985, rents surged, particularly in Sydney and Perth, and the policy was reversed within two years. There’s no reason to believe the rent outcome would be different this time.
Should I just buy new residential property then?
Investing is about total return. While brand new property will be exempt from these changes, it doesn’t always mean you should buy brand new.
In the long run, land goes up in value and buildings go down. A new property with a high land component amount may still be a good investment. Every investor should do the numbers and make sure that the investment will make money. An established property paying higher CGT and deferred negative gearing benefits may still produce a better overall after-tax return.
The government has failed to reach targets on new builds due to the availability of labour and rising material prices. Pushing more people towards investing in new builds will only exacerbate the current issues and see construction costs rise further. In most markets, the construction sector is already running at full capacity.
I would also be wary of those who operate on the model of providing house and land packages to sell as investments. Get as much information and advice as you can, as that off the shelf approach may not suit, and unassumingly put a dent in your long-term strategy.
Should I invest in residential property anymore?
For those wondering whether the tax changes mean residential property may no longer be a good investment, consider what the market has absorbed over the past two decades – a global financial crisis, pandemic, wars, aggressive interest rate cycles. Through all of it, Australian property has proven resilient. Why? Because it always comes back to supply and demand. That equation hasn’t changed, and it won’t. We have a shortage of properties. Pushing investors into new property won’t help too much right now given the capacity constraints means, regardless of demand, we can’t build many more homes.
Cash flow on the purchase of established residential properties will be tighter in the short term, but rising rents will help offset some of that pain. The losses deferred will eventually be used when the property becomes positively geared, or you have other income, such as commercial property investments, to offset the losses.
Should I switch from residential property to commercial property sooner?
As many of you know, our philosophy has always been to build a balanced property portfolio, which includes a mix of commercial and residential property investments. Commercial property is usually positively geared, which helps with cash flow. Depending on your circumstances, it may make sense to invest in commercial property (either directly or through a fund) sooner but each person’s portfolio and circumstances are different.
The tax changes don’t remove the benefit of either class of property investment. It just means your personal mix may be different, and you may find yourself considering commercial investments sooner than expected in your portfolio growth.
What should I do right now if I’m thinking of buying a residential property investment?
First, you should look at your cashflow. Most investors pay the costs throughout the year and don’t get the tax benefit until they lodge their return. The tax refund was always a nice benefit, however if you didn’t necessarily need that injection of a tax refund, then nothing changes.
You should continue to look at good quality investments to build out your property portfolio. New property might be a consideration for some but remember that growth is still critical to drive overall returns. Tax benefits just help along the way.
The fundamentals don’t change. Supply and demand drive the market. We are still optimistic about residential property and its place in a balanced property portfolio.
We will continue to monitor the budget breakdown closely and keep you updated. We have always approached investment by tailoring a plan to an individual’s circumstances and now is no different. We will still work alongside every investor to understand their goals, roadblocks and structure and build a strategy that aims to grow wealth through property.
If you have any questions about the recent announcement, please do reach out to your consultant or accountant to get some perspective on exactly what it means for you.