Labor has announced that if they are ushered into Government at the next federal election, they will (amongst other things) stop negative gearing (except for newly built properties) and halve the CGT discount from 50% down to 25%. More recently they have given taxpayers more certainty by announcing that the start date for these policies would be from 1 January 2020. This means that existing investment properties will be grandfathered, and only investments purchased after 1 January 2020 will have the reduced CGT discount and not be able to be negatively geared.
So here are some questions that arise from this latest announcement:
- Should I try to purchase a property before 1 January 2020 to lock in negative gearing and capital gains tax discount at 50%?
- Is it still worthwhile to buy established properties as investments after 1 January 2020?
Buying a property before 1 January 2020
Yes, you can still purchase newly built properties after 1 January 2020 and receive negative gearing benefits (but not receive the 50% CGT discount). But if you wish to purchase existing properties and negative gear them and lock in their 50% CGT discount status, you will need to do so before 1 January 2020.
Often existing properties are preferable to newly built properties because:
- They will more likely be in well-established suburbs (rather than new estates) where the land is more likely to increase in value over the long term; and
- You do not bear the risk of purchasing a property off the plan e.g. builder goes bankrupt and leaves property unfinished; also costs may be uncertain; and
- New properties are usually purchased at a premium price.
As finance from banks is becoming harder to get post-Royal Commission and regulators crackdown on the amount of borrowing in the economy, if you want to purchase prior to 1 January 2020 the time to start is now to allow time to locate a property and obtain finance. Also keep in mind that even though there is a deadline, you do not want to rush into anything and make a bad decision.
Buying a property after 1 January 2020
So would it still make sense to purchase an established investment property after 1 January 2020 if Labor were to gain power in the next election? Well maybe. Our advice has always been to purchase a property for its long-term growth potential as the primary factor, and not because of negative gearing tax benefits – those being just a sweetener. But to break it down, we will use two like-for-like examples, the only difference being that one will be based on pre-1 January 2020 rules and the other on post-1 January 2020 rules.
In the table below you will see the difference to your cash and tax refund using the ‘pre’ and ‘post rules. We have assumed a $700,000 purchase price and a rent is to be 3% of the purchase price and interest rate is to be 4.5% on a loan of 90% of the home’s purchase price. Some of the assumptions used in calculations in this table are simplified (for example, costs stay the same; rental yields do not increase year after year; and there are no adjustments for inflation) but the idea is to give you a comparison of the effects of the changes in legislation with all else being equal.
Note: I have also assumed that all the non-deductible losses under the post-1 January 2020 rules will be able to be accumulated and used to offset your capital gain in the future.
As you can see in the table below with the ‘pre’ (existing) rules your actual loss after factoring in tenant income and tax refund from negative gearing is $4,007 per annum. Whereas with the ‘post’ (proposed) rules your actual loss with no tax refund due to negative gearing would be $11,550 per annum.
| Assumptions | |
|---|---|
| Purchase price | $700,000 |
| Rental yield | 3.0% |
| Loan-to-value ratio | 90% |
| Loan interest rate | 4.5% |
| Capital growth p.a. | 5% |
| Pre | Post | |
|---|---|---|
| Rental Income | $21,000 | $21,000 |
| Less | ||
| Loan Interest | $28,350 | $28,350 |
| Other Costs | $4,200 | $4,200 |
| Cash loss | -$11,550 | -$11,550 |
| Depreciation deduction | $1,500 | $1,500 |
| Capital works deduction | $3,000 | $3,000 |
| Tax loss | -$16,050 | $ – |
| Tax benefit at 47% rate | $7,544 | $ – |
| Cash loss after tax | -$4,007 | -$11,550 |
So year-on-year this doesn’t look great for things under the new rules.
Now let’s look at another table, this time we are assuming the same details, but the house is to be owned for 10 years’ time and then sold at the market rate. We have assumed a conservative 5% per annum growth rate. The table shows each year’s growth and then the blue column shows that growth after the cash loss under current rules, whilst the orange column shows that growth after the cash loss under the proposed post-1 January 2020 rules.
| Pre | Post | ||||
| Year | Growth | Cash Loss | Net Growth | Cash Loss | Net Growth |
| 1 | $35,000 | -$4,007 | $30,994 | -$11,550 | $23,450 |
| 2 | $36,750 | -$4,007 | $32,744 | -$11,550 | $25,200 |
| 3 | $38,588 | -$4,007 | $34,581 | -$11,550 | $27,038 |
| 4 | $40,517 | -$4,007 | $36,510 | -$11,550 | $28,967 |
| 5 | $42,543 | -$4,007 | $38,536 | -$11,550 | $30,993 |
| 6 | $44,670 | -$4,007 | $40,663 | -$11,550 | $33,120 |
| 7 | $46,903 | -$4,007 | $42,897 | -$11,550 | $35,353 |
| 8 | $49,249 | -$4,007 | $45,242 | -$11,550 | $37,699 |
| 9 | $51,711 | -$4,007 | $47,704 | -$11,550 | $40,161 |
| 10 | $54,296 | -$4,007 | $50,290 | -$11,550 | $42,746 |
| TOTALS | $440,227 | -$40,065 | $400,161 | -$115,500 | $324,726 |
As you can see under the old rules you will have $75,435 extra growth captured after factoring in the cash loss each year for 10 years.
The only piece of the puzzle missing now is to factor in the affect of the reduced capital gains tax (CGT) discount under the old and new rules. That is, the ‘pre’ rules giving a 50% discount on the capital gain, with the proposed ‘post’ rules only giving a 25% discount. The next table shows the effects of this.
| Pre w/ 50% Discount | Post w/ 25% discount | |
| Taxable capital gain | $220,113 | $209,795 |
| Tax at 47% rate | $103,453 | $98,603 |
| Capital gain less CGT | $336,773 | $341,623 |
| Less: 10YR Cash losses | $296,708 | $226,123 |
| Real 10YR gain | 42% | 32% |
| (Per annum over 10 years) | $29,671 | $22,612 |
| (Per annum over 10 years %) | 4.24% | 3.23% |
So the accumulated 10-year gains, less our cash losses each year, and less capital gains tax (CGT) show that under the current ‘pre’ rules we would have a real gain of $296,708 (or 42% on our initial $700,000 investment) and under the proposed rules the real gain would only be $226,123 (or 32% on our initial investment). If you spread this over 10 years, we have averaged 4.24% real gain under the current rules which drops to 3.23% under the proposed changes.
So, while 4.24% after costs and taxes per annum seems respectable, if you had a return of only 3.23% some might be tempted to look at term deposits or other “safe” investments rather than put your money into a property. Or even shares which will also be affected by the negative gearing and CGT changes, but have a much lower cost of entry.
What this shows us is if buying existing property after 1 January 2020 you really want to pay attention to location and land value because you will need high growth to get a large enough return after cash losses and CGT are factored in to make it an attractive investment. Quality becomes more important.
Also, it shows the importance of doing your sums if the new rules were enacted, to see what type of return you will be getting once the tax effects are factored in. It might be the case that if the growth is high enough in an existing property, that it might give a better return than a brand-new property in a low growth area that gets negative gearing benefits. Maybe the gold standard will be to purchase a newly constructed property on land in a well-established blue chip suburb (which would be quite rare).
CGT Discount issues
While will are discussing these changes, it is worth mention that you should consider holding onto assets purchased pre-1 January 2020 longer than you otherwise would, because if they have a likelihood in increase in value significantly over the long term, than this is more growth that will be taxed at a lower rate with the 50% CGT discount. This is opposed to purchases after 1 January 2020 where CGT discount will only be 25%.
Of course, you need to consider the growth prospects of the particular assets e.g. if a property, is it located in a good suburb? If shares, are they blue chip? Consider which assets you have that should be marked for holding longer term.
Conclusion
Please keep in mind that the time between the election and 1 January will be quite short. Labor may or may not be able to get the legislation passed for these changes in time. There are also plenty of unanswered questions about the specifics of these policies that we need to see. There is a risk that the changes do not happen or there are some unforeseen issues that arise due to the specifics. As always, investment decisions should be based on their inherent value without focussing overly on the tax benefits.
But it seems that if you wish to purchase an established property and have the capacity to do so before 1 January 2020, that it would definitely be worth moving forward with the purchase as soon as possible providing it is in a good location (e.g. good suburbs in capital cities) and a good type (e.g. not an apartment).
And if you will purchase after 1 January 2020 you (or your adviser) should do the relevant calculations to determine the potential gain after factoring in lack of negative gearing and a reduced CGT discount – and pay attention to quality (good location/property type).
