Capital gain pain is on the cards if Labor’s tax plan proceeds

A Labor federal election victory next year is looking likely, according to the polls, and that means real estate investors are about to be hit by expensive tax changes.

A WAR of words is raging about the Labor Party’s plans to overhaul negative gearing, but a more painful tax threat is lurking in the shadows for real estate investors.

If Labor wins next year’s federal election, it wants to scrap negative gearing tax deductions for future property purchases, except for new homes. It’s infuriated many in the real estate industry who already are battling sharp house price falls in several capital cities.

Negative gearing — where investors claim tax deductions when their expenses such as interest and council rates exceed their rental income — has always been popular, but looks to be on its last legs for all but new properties.

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There have been colourful comments opposing the planned changes. Aussie Home Loans founder John Symond this week described it as a “nuclear bomb” that could tip Australia into recession.

Property researcher Louis Christopher was also worried about a recession and said bringing in the changes during a housing downturn was very risky.

Labor’s response has been that it simply wants to level the playing field to help more Australians own a home.

Aussie Home Loans founder John Symond described Labor’s capital gains tax plans as a “nuclear bomb”. Picture: Darren Ornitz

While negative gearing hogs the negative spotlight, Labor’s planned changes to capital gains tax rules will potentially pack a much nastier financial punch.

The negative gearing changes might cost investors a few thousand bucks a year, but the capital gains tax changes could eventually cost them tens or even hundreds of thousands of dollars.

Labor wants to slash the current capital gains tax discount in half, from 50 per cent to 25 per cent.

That may sound like financial gobbledygook, but look a little closer and it may frighten you.

Under our current CGT laws, any asset — investment property, shares or something else — that is sold is subject to tax on the capital gain. Rather than a specific tax rate, the gain is just added to a person’s taxable income in the year of sale and taxed at their marginal tax rate.

If the asset was held more than a year, only half of the gain gets added to taxable income. That’s the 50 per cent discount in action. Labor plans to cut that 50 per cent discount to 25 per cent.

To put it financially, an investment property bought for $500,000 and sold many years later for $1 million creates a $500,000 capital gain. Under the current 50 per cent discount rules, half of that gain — $250,000 — gets added to the investor’s taxable income in the year of sale.

That would push at least part of the investors’ income into the 47c in a dollar tax bracket, creating extra tax of up to $117,500.

Under Labor’s plan, a higher figure of $375,000 would be added to the investor’s income, producing a much higher tax bill of up to $176,250.

Both the negative gearing and capital gains tax changes are not retrospective and would only apply to future investments.

However, they are likely to change investment decisions, and result in two classes of property investors — one lot unhappier than the other.

@keanemoney