Explaining capital gains tax and negative gearing
Understanding Australian property tax and modelling pathways to reform
What is a capital gains tax?
When an investment property is sold for more than it cost to buy, the difference between the low buying and the high selling price is called a capital gain.
In September 1999 the Australian Government changed the capital gains tax (CGT) payable by investors so that, if the property had been owned by an investor for more than 12 months, only 50 per cent of the nominal capital gain (i.e. after allowing for associated costs that weren’t otherwise claimable) is included as assessable income to be taxed at the individual’s rate of taxation.
This tax discount encourages investors to buy houses to get capital gains benefits rather than rental yield that, like money earned from a bank deposit or as dividends from shares, is taxed at 100 per cent of the investor's rate of income tax.
What is negative gearing?
Negatively gearing is the process whereby a property investor can deduct their property expenses (such as the interest on the loan required to buy the property, depreciation costs, land taxes, rates and maintenance costs) from both the income they receive as rent from the property and from other sources of income (such as their salary or other non-housing investments), thereby reducing their overall tax bill.
The actual purchase cost of the property is not claimable for negative gearing purposes.
Modelling changes to CGT
AHURI research undertaken in 2011 modelled a 10 per cent increase in the capital gains tax payable by investors from 50 per cent to 60 per cent. This would decrease the tax shelter benefits of negatively gearing (though they are not removed) and reduce the incentive for investors to rely on achieving capital gains as the main reason for property investment.
The modelling showed negatively geared investors may see rental investments as less financially attractive and sell them, thereby increasing the available housing for first homebuyers and reducing housing prices (or at least slowing increases in housing prices).
An increase in capital gains tax would also see a boost in after-tax returns for investors who are positively geared (or own their rental properties), which will make them more likely to hold rental properties. Because of their lower tax burden, these investors would now be able to charge lower rents, which would be a benefit to lower income households.
AHURI research, ‘Income tax treatment of housing assets: An assessment of proposed reform arrangements’, is currently underway, modelling pathways to reform the income tax treatment of property assets, including capital gains tax provisions and negative gearing. The project is analysing the distribution of housing tax expenditures under current tax provisions, as well as the potential distributional and behavioural impacts of alternative reform scenarios.