The upcoming Federal election has thrown up some key issues for voters, not least Labor's proposed plan to abolish negative gearing and make changes to capital gains tax (CGT) for residential property.
As a property investor, you need to understand the implications of these so you can assess what impact they could have on your financial position. First, let's remind ourselves what negative gearing and CGT are, before we look at what effect these policies could have on the property market.
What is negative gearing?
Gearing is borrowing money to invest, including in property - normally in the form of a mortgage - to finance your investment property purchase.
If the income (rent) from your tenants does not cover the cost of your loan you are said to be negatively geared. There are tax advantages to being negatively geared, as you can offset these to reduce your taxable income.
If the income from your investment property covers the interest and repayments of your loan, and all other expenses, then you are said to be positively geared.
What is capital gains tax?
You are liable to pay Capital Gains Tax (CGT) on any profit you make from an investment, including the sale of an investment property. It does not apply if you sell the property you live in, i.e. your primary place of residence.
You can work out your capital gains tax by taking the selling price of your investment property and subtracting the cost of the property plus all the expenses incurred managing it. The remaining amount is your capital gain. CGT is assessed in the tax year that the sale of your investment property took place.
Understanding Labor's proposed changes to negative gearing and CGT
So what exactly are Labor's proposed changes to negative gearing and CGT? According to the ALP policy platform they will:
Limit negative gearing to new housing from 1 January 2020. All investments made prior to this date will not be affected by the changes and will be fully grandfathered.
Halve the capital gains tax discount for all assets purchased after 1 January 2020. This will reduce the capital gains tax discount from assets held longer than 12 months from 50 per cent to 25 per cent. All investments made prior to the 1 January 2020 will be fully grandfathered.
What is behind Labor's proposals?
Labor's proposed changes to negative gearing are aimed at "improving housing affordability and support housing construction".
They argue that Australia currently has overly generous property tax concessions that predominantly benefit high-income earners, and lock first home buyers out of the housing market. First home buyers and owner-occupiers are currently competing with investors for the same properties. By reducing investor tax breaks, it aims to reduce investor demand for existing houses, which is also likely to reduce house prices.
Labor's policy manifesto maintains that, "70 per cent of the benefits of the CGT discount and 50 per cent of the benefits of negative gearing go to the top 10 per cent of income earners.
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."
Labor contends that their two proposed policies will be good for home ownership as they will help put first home buyers back on a level playing field with investors.
What will the impact be on investors?
The term 'grandfathering' means that if you owned a property prior to 1 January 2020, you are still able to negatively gear it or claim the full 50 per cent CGT discount after that date.
However if you purchase an existing property - as opposed to a new build - after this date, negative gearing is not an option for you, and you will only be able to claim a 25 per cent capital gains tax discount after you sell your investment property.
What does the property sector think about Labor's policies?
Investment research house SQM Research, who specialise in property investment, believe that negative gearing reform is a good thing over the long term, but contend that the policies are risky in a cooling market.
It predicts property prices will fall nationally by between 5 per cent and 12 per cent by 2022 if Labor wins the Federal election.
In another scenario, where the Reserve Bank cuts the interest rate by half a per cent, SQM believes the market would drop between 4 and 8 per cent. They also predict landlords will be forced to raise rents to make up for the reduction in available tax concessions.
Some industry bodies have criticized the proposals, including the Property Council of Australia who are "deeply concerned about the potential impact it may have on housing markets and the broader economy at this uncertain time in the cycle".
The Real Estate Institute of Australia (REIA) has also come out against the Labor Party's tax policy, stating that it is, "concerned with the impact the policy would have on housing markets, buyers, renters, and economic activity".
Others, such as the independent Parliamentary Budget Office, estimate that limiting negative gearing and reducing the capital gains tax discount will substantially boost the government's coffers, to the tune of $32.1 billion over a decade.
All opinions aside, Labor first needs to win the election. It is then likely to coordinate how and when it implements these policies with the Reserve Bank of Australia (RBA) and Australian Prudential Regulation Authority (APRA).