Changes to the capital gains discount and negative gearing are likely to change how Australians invest their money, experts say.
The Albanese government unveiled ambitious tax reforms as part of the budget released this month, sparking debate on how Australians should be taxed.
The changes include replacing the 50 per cent capital gains tax (CGT) discount from 1 July next year and limiting negative gearing on properties purchased after 12 May to new builds.
Jeff Coulton, associate professor in accounting at the University of New South Wales' Business School, says he believes the changes will trigger a "structural reallocation" of capital.
It changes the relative attractiveness of certain assets compared to other assets.
Coulton believes property investment will likely shift towards newly built homes, and share market investors will favour companies in Australia that pay dividends.
He notes the budget measures have not yet been legislated and are subject to negotiation before being finalised.
"But assuming the announced budget measures are reflected in the final enacted law, I think it would be a relatively major change in investor behaviour because it does dramatically change the relative attractiveness of certain types of investments."
Share market shift
There are two ways investors generally make money from shares: gaining a share of the profits (dividend income) or selling their stock for more than they paid (capital gains).
Coulton says the CGT changes make selling stock less attractive and this will impact riskier investments in businesses, such as start-ups, the most because they are more likely to invest profits back into their operations rather than pay shareholders a dividend.
"Early-stage investors will typically be looking for a capital return rather than a dividend return, and the proposed changes have made a capital return relatively less attractive," he says.
Instead, money may be shifted to shares in established companies, such as the major banks and mature mining and industrial companies, because they are more likely to pay dividends to shareholders.
Preference could also be given to companies that pay tax in Australia because they receive franking (or imputation) credits that investors can use to reduce the tax they pay on dividends.
"This budget didn't do anything to alter this dividend imputation system, but what it did do is it made franked dividends relatively more attractive because the capital gain side has become less concessional," Coulton says.
But he says young people are often better off investing in riskier companies that don't pay dividends, because they have more time to ride the ups and downs of the share market, and riskier investments generally deliver higher long-term returns.
I think it discourages young people from making the riskier investments that, with their investment horizon, would normally be optimal to make.
Economist Saul Eslake says changes to CGT could be more generous to share market investors than the previous 50 per cent discount, although some may be worse off depending on the actual performance of their investments.
He says the current discount is most advantageous if the value of a given asset has risen at more than twice the rate of inflation.
He notes that while house prices have risen by 7.5 per cent per annum on average over the last 25 years in Australia's eight capital cities — which is more than double the average inflation rate of 2.9 per cent — units have only risen by 5.5 per cent and shares by 4.5 per cent.
This is one of the reasons why investment in houses became so lucrative.
"On average, the capital gains tax regime we've had since 1999 has been harsher on investors in shares," Eslake says.
Under the new system, investors will be taxed a minimum of 30 per cent on the profit after inflation has been taken into account.
Eslake also notes that few people borrow money against a share portfolio and will not be impacted by the changes to negative gearing.
The family home
When it comes to property investment, Hudson Financial Planning managing director Juanita Wrenn says people's principal place of residence has emerged as a huge winner of the budget.
These homes remain CGT-free, which means you can sell them without paying tax on the profit.
Wrenn says many of her clients are now looking to put more money into their homes.
People talk about upsizing now for retirement, moving family into their homes or buying a large acreage and building their community on that acreage.
Because the negative gearing arrangements have been grandfathered, many of her clients are also talking about moving out of their principal place of residence, which can still be negatively geared, and buying another property as their home so they can rent out their current residence and take advantage of the tax benefits.
"People will hold on now to what they've got because you will never get this sort of tax advantage again if you own property right now in Australia," she says.
"But on the flip side, negative gearing isn't everything."
The leverage of property is still there
Wrenn says the advantages of investing in property remain.
Firstly, for those who find it hard to save, property is an illiquid asset that you can't easily take money out of.
Secondly, it offers greater leverage.
Wrenn says with $100,000, someone could apply for a $1 million loan (with a 10 per cent deposit) and enjoy significant returns on this investment in 10 to 15 years.
In contrast, if you were brave enough to borrow against a share portfolio, you might get $150,000 on a 60 per cent margin loan (a loan that allows you to borrow 60 per cent of the portfolio's value), but you are still only looking at investing $250,000 in the share market.
"The return over the next 10 to 15 years on $250,000 is a lot different to the return on $1 million," Wrenn says.
"So the leverage of property is still there and property is still an asset class, it's just the negative gearing that's gone."
Negative gearing workarounds
Wrenn notes it is still possible to carry forward losses; if you make a loss on a property, you just can't claim it against your income each year.
She says losses can be claimed against the cost base of a property, reducing the CGT paid when it's sold.
"So it's not like it's totally a loss. You're just not writing that loss off every year," Wrenn says.
It's not quite as bad as it first seems when you do the figures.
For those who have several properties — such as five or six — with some positively geared and two or three negatively geared, it's also possible to offset the losses of the negatively geared properties against the positively geared ones.
"So your property portfolio can pretty much run itself if you've got enough money to own four or five properties.
"The more properties you have, the better off you actually are."
While it's still possible for people to negatively gear new builds, Wrenn says this means you're generally buying in the outer suburbs if you are buying a house.
"You're [probably] giving up growth just to get negative gearing," she says.
"Depending on your situation or your portfolio, that's not always the right thing to do either."
Despite the changes, Wrenn doesn't believe Australians' love of property will change.
"I still think property is an amazing asset to hold; you just have to look at the way you’re going to structure it and the way you’re going to hold it. Be aware of your losses.
"I don't think taking away negative gearing is going to stop people buying property — investors or people who have money — because there are workarounds."
Self-managed super funds
Financial experts say there's now talk about self-managed super funds as a way to bypass changes to the 50 per cent CGT discount.
Wrenn says that someone who buys a property using their super fund — as long as there's less than $3 million in their account — will pay zero CGT if they sell it once they retire and are in the pension phase.
"You only need $300,000 to $400,000 in a self-managed super fund to make it a really viable option," she says.
So I think what people will start doing is using self-managed super funds more.
Wrenn says franking credits also help to offset CGT.
Equally, if these shares are owned by a super fund in the pension phase, any dividends will be exempt from tax — plus you get the franking credit.
"My advice to anybody over the age of 45 is to pile up your super over the next 10 to 15 years."
While Wrenn acknowledges the government could change the rules at some point, there is still a huge gap in the benefits of investing using a super fund — whether that be property, shares, physical gold or anything else — as opposed to buying it in your own name.
"When you retire, that is tax-free income — there's nothing that beats super and your own home.
"At the most simple level, they're the two best investments in Australia right now."
This article is general information. Please see a professional if you need financial advice.
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