Is there a smart Property Tax solution?

Lately we have seen the negative gearing debate rage. Current sentiment is “no change”, but it is interesting to see the arguments run, all of which may now be superfluous (including this one) however as we saw on Monday, things change quickly in Canberra. (What is Negative gearing? – It's using the interest payments on a loan as a tax deduction)

There are actually four property taxes that influence the market behaviour of property investors and home buyers.

The Fab 4 property taxes are…

1. Negative gearing (Federal & investment only)
2. Land tax (State & all property over a threshold value)
3. Stamp duty (State & all property sold - less for "off the plan")
4. Capital gains tax (Federal & investments only)

Each one has its hand on a lever that impacts the market, but as you can see, different governments control different levers so I doubt we are ever going to get a smart and economically productive solution to property taxes? If you have one, please share.

The impact of removing negative gearing and adjusting its stable mate CGT, depends on the detail such as…

•    Is it removed just on property or all asset investments?
•    Is it just residential property?
•    What kind of residential property – new or existing?
• Will be grandfathered for existing arrangements?

Subject to answering these, the impact of changes to negative gearing on capital or rental values will actually be minimal especially given how low interest rates are. There was a great article by Richard Holden and Saul Eslake on this recently in the AFR. It will however, be most pronounced on smaller or “investment" apartments which appeal almost exclusively to investors. So focusing just on this sector the popular belief is removing negative gearing makes it less attractive, so prices fall and new supply reduces, forcing rents to rise in response to the reduced supply. This is thought to encourage some renters to become owner-occupiers, stabilising the market.

There is a view that if rental values rose, so should capital values, but the taxation landscape has changed in this scenario, and there is a new valuation paradigm requiring a higher yield. (income to value ratio)

One wrinkle in this argument is the supply of new apartments has about a 1-2 year supply lag so any tax change today will take about 1 - 2 years to materialise, and the property market has longer cycles than most governments (let along Prime Ministers). The other stretch logic is that renters will become buyers. Remember a renter needs about a full years rent just to pay stamp duty plus the equity of 20% (or more if the market is falling and banks are tightening up), so this won’t happen in any significant way.

If we follow world trends, negative gearing will be eventually be reduced in Australia one day.

This article was originally posted by Andrew Wood, Managing Director of Wood Property Partners.