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New laws around negative gearing & Capital Gains Tax (CGT)
Author: Wagdi Wafik Andrawis
What is negative gearing?
Over the past few months Silver Peacock accountants & tax specialists have been receiving calls from clients enquiring about the new laws around negative gearing. It is important to first understand what is Negative gearing and how does it benefit your tax return?
Negative gearing occurs when an investment property is purchased with the assistance of borrowed funds from a financial institution and the net rental income i.e. after the deduction of expenses is less than the interest on the borrowings resulting in a rental loss.
Therefore, you can claim a deduction for the full amount of rental expenses against your rental income and other income including salary, wages or business income when you complete your tax return for the financial year reducing the taxable income. If the income is not enough to absorb the full loss, the loss can be carried forward into future financial years.
Therefore, it is important to plan a head, Silver Peacock accountants & tax specialists will generally advise you to plan for the following financial year if it is evident that there will be future rental losses, this allows you to recalibrate your tax strategy and re-adjust your rate of withholding to better match your year-end tax liability facilitating for a better cash flow.
Why would an investor invest in a loss making investment?
Silver Peacock accountants have been asked, why invest in such properties when an investor is buying property to make money, not lose it. Our answer is simple when we apply a cost versus benefit analysis. Meaning, the benefit of purchasing a loss-making investment property is that any short-term losses will be outweighed by the long term capital gains.
Research conducted by Silver Peacock have also shown that many investors have a mindframe and expectation that rental income will increase over time as property prices inflate resulting in increased rental demands in the area. Therefore, negatively geared properties are likely to become positively geared once the income exceeds the interest and expenses. In the interim, the investor will also benefit from the short term tax benefits of negative gearing.
Our study has shown that generally investment properties which are purchased in those areas which have a lower rental yield will most likely be negatively geared, however, those areas tend to rise in value more than regional areas in the long term, as a result investor expectation is that the negatively geared properties will increase in value enough to cover the loss.
What are the proposed changes to negative gearing?
If elected, Labor has announced that it will implement its plan to restrict negative gearing to new investment properties starting from January 2020.
This effectively means that investors can only deduct rental losses from other income including salaries and wages to reduce taxable income from newly constructed properties.
For all investments that have been purchased before the changes come into effect will be grandfathered, meaning, investors who purchased existing properties before the commencement date of the new rules, will still be able to claim rental losses against other income including salaries and wages effectively reducing taxable income.
However, although under the new rules investors can not deduct the rental losses from other income including Salaries and Wages, they can still be offset against other investment income such as share dividends received to reduce taxable income or the rental losses can be carried forward to offset the capital gain on the property when it is sold.
Therefore, this means that investors will still reep the benefits of rental losses where they can claim losses from rental properties, but not necessarily in the financial year that the losses were incurred.This may make it more expensive for an investor to hold a loss making property in the short term, as an investor may expect lower cash flow when purchasing a negatively geared property.
The labor party is also proposing some changes to CGT that applies on the proceeds that result from the sale of assets such as properties and shares. Currently, investors who sell an asset are only liable to pay tax on 50% of the capital gain at their marginal tax rate if the investor held the asset for longer than 12 months.
However, the proposed changes by labor will reduce that discount from 50% to 25% meaning investors will have to pay tax on 75% of any capital gains. This will apply to both new and existing properties purchased after the date this change will take effect.
Like negative gearing, the proposed capital gains tax changes will also be grandfathered, meaning investors who have purchased properties prior to the commencement date will be unaffected and will still receive the 50% discount.
If you have any questions, please contact Silver Peacock & Co and talk to one of our accountants and tax specialists by calling us on 1800 983 448 or send us an emil to firstname.lastname@example.org.
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