On the 13th of this month Bill Shorten announced plans to reduce the Capital Gains Tax Discount (CGTD) from the current 50% to 25%. Unlike the proposed and highly controversial Negative Gearing changes, the CGTD is more likely to get through parliament, so let’s break down what it all means for investors.
Let’s start this article off by defining a few key terms. Capital Gains Tax is a dollar amount you must pay the government based off of the profits that are made when selling a property. The Tax takes into account not only the upfront cost of the property, but also the relevant costs involved with maintenance. For example, if you purchased a property for $300,000 and spent $20,000 renovating it, before selling it for $400,000, you would have made $80,000 in capital gains.
Inversely you can also make capital loss, which would be when the costs involved with the purchase of a property outweigh the sale value. For example if you purchased a house for $300,000 and sold it for $280,000. This would be a capital loss of $20,000. While it is definitely not preferable, capital losses are not the end of the world as you can use them to reduce a capital gain in the same income year. In other words, if you have multiple properties you can reduce the losses of Capital Gains Tax by using the capital loss of another.
So that’s Capital Gains Tax, but what about the Capital Gains Tax Discount?
The complexity of a real world property sales are however more complex than the simple subtraction method we talked about earlier. The method for determining your capital gains tax is also dependent on how long you have held the property before selling. If you hold for longer than 12 months, then you can currently get 50% off the Capital Gain figure we calculated earlier.
For example, a house purchased for $300,000 in 2012 and sold today for $400,000 would incur a capital gains tax of $100,000. However because the property has been held for longer than 12 months, that $100,000 figure becomes $50,000.
Now back to the news of the day. The Shorten government, on Saturday, has suggested that the 50% Capital Gains Tax Discount should be changed to 25%.
The reasoning for this?
It all comes back to affordability. Those who already own property can use significant tax breaks already in place, be it negative gearing or the CGTD, to price new home buyers out of the market and ultimately push the price of housing up. Think about it as if you were selling your home. There are two potential buyers, one is a first home buyer and the other is a property investor with multiple properties. The first home buyer is limited by their savings and their income stream in the purchase of the property, whereas the investor has savings, an income stream and existing assets in property. If the property is worth the cost, the investor can raise the price to a level he/she can afford but the first home buyer cannot, thus pricing them out of the purchase.
The idea behind reducing the CGTD is to reduce that ability of existing investors to price out new buyers. If the expected return at the end of the investment is less, then there is less to use as leverage at the initial purchase point. This can get a bit more complicated so let’s break it down.
A property at the value now of $300,000 is expected to be worth $350,000 at the end of 12 months. The Capital Gain at the end of the period is $50,000 which with the current discount level would be $25,000 of taxable profit, and $25,000 which is just straight profit. Knowing this, an investor looking at the property should be willing to spend somewhere around $325,000, as the profit in 12 months outweighs the initial cost. Now with the new percentage that Shorten wants to introduce, that $25,000 figure of taxable profit becomes $37,500, leaving only $12,500 as leverage at the initial purchase of the property.
Of course the taxable amount is all dictated by the individual’s income bracket, so wealthier tax payers will stand to lose more and thus be less able to price new players out of the market.
What is your opinion on Shortens planned CGTD changes? Be sure to leave a comment below and let us know your opinion!