By Noel Whittaker Sunday Times 29 July 2018
Capital gains tax will be a big issue as we approach the next election. The coalition has promised to leave it unchanged; Labor wants to increase it, reducing the discount from 50 percent to 25 percent.
Prior to 1985, Australia had no specific capital gains tax, but the legislation allowed the tax office to tax a capital gain if it believed the intention at the time of the purchase was to resell for a profit. This was a most unsatisfactory situation because even the best tax accountants could not give an unequivocal statement as to whether a gain would be taxable — the answer was not known until the asset was sold and the gain assessed.
While everyone found it unsatisfactory, there was still a general agreement within the major parties that some form of capital gains was a must.
So in September 1985, the Hawke government introduced capital gains tax, to apply only to realised gains on assets acquired after that date.
Obviously, it would be unfair to tax a purely inflationary gain, so from 1985 to 1999 an indexation system applied, which allowed for the effect of inflation before calculating the taxable capital gain. An averaging system was also introduced to lessen the impact of a capital gain moving people to higher tax brackets.
Those of you who practice dividend reinvestment will remember what a pain this indexation system was, as every single transaction had to be given a separate cost base — it was a nightmare.
In 1999, in the interests of simplicity, the Howard government abolished the indexation and averaging provisions, replacing them with a system in which realised gains on assets held for over a year were allowed a 50 per cent discount.
It was a much simpler system and was welcomed by the investing community generally.
But tax laws never stay still. Last year Labor launched a two-pronged strategy to make housing more affordable by discouraging investors from buying residential real estate. This involved the abolition of negative gearing for people buying established houses, and an increase in capital gains tax.
That decision was taken in the context of an overheated housing market, which is certainly not the the position today.
Labor claims these changes would not be retrospective, and would not apply to any properties purchased before Labor puts its changes into effect.
Will it make much of a difference? Think about a person earning $90,000 a year who makes a capital gain of $100,000. Under the coalition they would pay tax of $19,500, an effective rate of 19.5 percent of the gain, but under Labor’s new rules $29,250 an effective rate of 29.25 percent.
To be frank, I don’t think it’s a big deal. The numbers are not huge, and most people who buy investment properties intend to keep them for their retirement. This puts capital gains tax way out into the distance. [note: until Labor & The Greens introduce death duties as foreshadowed recently]
But what will be the effect on the real estate market?
It may encourage some to sell properties believing that the combination of an increase in capital gains tax and the restriction on negative gearing may make investment property less attractive and therefore lead to a reduction in prices.
Or investors may take the view that a pre-Labor capital gains tax property is worth holding on to, which could reduce the of investment properties on the market and push up prices.
Now add to this heady mix the certainty that interest rates will go up and property prices may fall. You cannot know what the market will do. The major factor in any decision should be the potential of the property.