Usually within hours of a Federal budget, there is plenty of commentary on what the budget means, how it will work, and who will benefit. This time though, crickets, which is because the changes are the most complicated and ill thought through in history. The hardest hit will be the aspirational middle class especially renters or those wanting to own a property or any kind of investment. This is an aspiration killer of a budget. So what is the impact, and what can you do to minimise your loss?
The “winners”: The only “win” for tax payers is the $250 WATO payment to be paid in July 2027. Except even that is not a win, as the average bracket creep for the two lowest tax brackets over the next year robs them of $440 on average first. So lose $440, then collect a “reward” of $250 – so workers are $190 worse off. And if you are a retiree or welfare recipient, you are even further behind.
The impact on Property: ALL property owners will be worse off, and most negatively affected will be renters followed by those who aspired to owning their own property (rental or place of residence).
Why? Because property is all about supply and demand, and from 2022 to 2028 Australia will have tried to absorb 2,000,000 more immigrants that all need somewhere to live – whilst property completions are DOWN 15%. In the past year alone, the average cost to build an average house has increased from $475,000 to $560,000. The totally dead cost of Government charges and compliance costs now account for just under half the cost of a new property, and is still rising. So even before considering the budget changes (impacts listed below), house prices and rents will continue to rise (even the budget itself is based on house prices rising, just by about 1-2% less than currently).
There are two significant tax changes for property investors. Firstly, Negative gearing will only be allowed in future on new buildings, and you will only be allowed to offset the property costs against rental income (not against salary as in the past). 80% of investors currently invest in existing property, so the claim that this will increase housing investment is questionable at best. Even if it does, investors are at a cross road: either sell off before June 2027 or hold for a long time into the future (to avoid the below CGT impact). As housing investment is generally a very low return investment that only works due to the hope of long term capital gain, few people will invest in buying investment properties.
The unquestionable outcome of the negative gearing change is that it will reduce the supply of rental property which will definitely lead to a lift in rent costs. Treasury’s forecast of the increase in rents of just $2 per week on an average $650 per week rent has been described by several industry institutions as “utterly delusional” (just like the assumption of 5% inflation this year and then just 2.5% every year in the future). For context, rents have jumped 55% since early 2020. Early forecasts are that investors will have to squeeze 15-30% more rent in the short term, with the prediction that the only investors to build houses will be US style corporate landlords seeking high rental returns (i.e. invest in small “dog-box” but high rent properties).
The negative gearing change was tried in 1985, something our Treasurer “Dr” Chalmers should know, as he is a Doctor in Political Science with his thesis being on Paul Keating. Keating implemented this change then, and rents skyrocketed whilst investment slumped leading to a shortage of rental properties and the market collapsed. 18 months later, the decision had to be reversed, and it took the market a few years to recover.
The biggest change in the budget is Capital Gains Tax changes, affecting ALL investments (probably shares even more than property). If you held an investment for more than 12 months, half the gain was not counted in your tax (as a simple way to offset inflation over time), so you were “only” taxed on half the gain at your marginal tax rate. In the future, there will be a minimum CGT rate of 30%, with the CGT rate indexed annually to account for inflation.
The value of a share on the stock exchange is likely to be known on the changeover date of 1 July 2027. However, how the CGT changes will impact all other types of investment (property and businesses especially) is anyone’s guess at present. The Treasurer gives 2 options:
- Tax payers seek a valuation as of 1/7/2027. There are 2.7 million family businesses in Australia and approximately 2.2 million Australians owning at least 1 investment property. Apart from that the Valuations industry always underestimates values (they have to), how will all these assets get valued on 1 day? Which leaves:
- Use the ATO apportionment formula tools that give an average return over the holding period. Investments usually have poor returns at the start and improve over time (property or business as it grows larger). The first few years are generally loss making, and then when the profit increases so does the value – and with this valuation method it means that the tax collected will be higher.
The Government says the CGT change is to help an extra 75,000 first home buyers enter the property market. What they don’t highlight is that is over 10 years, so 7,500 per year when we already have on average over the past decade 115,000 entering the market each year, so this is a 6.5% increase – effectively a rounding error, and in reality a real drop in access as just in January we had 57,000 extra immigrants added to the housing demand (so about 700,000 more people to house just this year alone).
In either case, it means that especially future investors will be left paying a higher rate of tax any time they sell. So investors are faced with 2 choices: sell before 1st of July 2027 (when many others are likely also doing so, giving sub-optimal sales prices); or decide to keep the investment “forever” (which even with the best intentions is not always possible due to change of circumstances for instance).
The final major tax change is the Family (or Discretionary) Trust crackdown. From now on, all trust income will be taxed at a minimum rate of 30%. The most common reason for choosing a Trust structure is Asset protection (the owners often put up the house as security), but it can give some tax benefits (usually minor and mainly in the first years when it is small). There are an estimate 1.8 million Australians that receive distributions from the 840,000 affected trusts. In some structures (such as when a Trust distributes to a company) this will lead to double taxation, meaning tax charged will be 51-62.9%. In many cases, trusts are for people starting small businesses, giving it a go often with the house on the line as a means of taking control of your own employment conditions. Often this is people on the lower end of the tax scales starting out, who will now be taxed significantly more than if they were a traditional employee. A person earning $45,000 will go from paying $4,288 to $13,500 in tax, a whopping $9,212 or more than 200% more in tax. This change does very little to get “the rich” to pay more tax, but significantly negatively impacts those on lower incomes.
So the smart strategy seems to be to wait and see what happens, and if the opportunity for you arises that it is beneficial to sell an asset, do so. Likewise if you are looking to buy (bearing in mind that interest rates will have to keep rising as inflation continues rising). But in either case don’t panic. The best option might just be to learn from the Keating experience and wait a couple of years for a change of Government to reverse these changes.
Words from the wise
“If you don’t take risks, you will always work for someone who does” – unknown.
“In this world, nothing is certain, except death and taxes” – Benjamin Franklin.
“We have a system that increasingly taxes work and subsidises non-work” – Milton Friedman.
As always, Onwards and Upwards!
Fred Carlsson
General Manager
