Capital gains tax: Changes coming to the ‘generous’ tax discount and what it might mean for Australians

Debates over Australia’s capital gains tax system are ramping up ahead of the May 12 Budget as economists and the Federal Government debate whether one of the country’s most generous tax concessions should remain unchanged.

Treasurer Jim Chalmers is being urged to dilute capital gains tax concessions in a bid to tackle what he called “intergenerational unfairness” within the tax system and housing market.

The Treasury is understood to be scaling back the current 50 per cent capital gains discount, but it’s unclear exactly how wide the scope will be.

Either way, change will be coming. But how will these changes affect Australians?

The Nightly spoke with Emeritus Professor of Taxation Chris Evans from the University of New South Wales to offer some insight into what these changes might mean for the average Australian.

What is capital gains tax?

Put simply, capital gains tax applies when someone sells an asset for more than they paid for it. The tax is applied to the profit — known as the capital gain — and is included in a person’s regular income for that year.

“It could be a property, it could be shares, it could be crypto, whatever, but when you sell that asset for more than you paid for it that’s a capital gain,” Prof Evans said.

However, the family home is exempt, as are certain personal-use assets and collectables below a specified value.

But otherwise, “anything which you might think of as being an asset, or something of value” will trigger the capital gains tax, Prof Evans explained.

The 50 per cent discount

One of the most controversial features of Australia’s CGT system is the 50 per cent discount.

If an individual holds an asset for more than 12 months before selling it, only half of the profit is taxed.

For example, someone who buys an investment property for $1 million and sells it for $1.5 million makes a $500,000 capital gain — but under the current rules only $250,000 would be added to their taxable income if they’ve held the asset for more than a year.

“You’re only going to be taxed on half the capital gain,” Prof Evans said.

“And then you’re taxed to your normal tax rates, whatever other income you’ve got, you added to it and whatever your rate of tax on that income is, then that’s the tax you’ll pay on it. “

Prof Evans said it was important to note that capital gains would be taxed at your top rate of tax.

“Your capital gain is added to your other income. So if you’re already earning over a couple of $100,000 a year, and you’re already on the top rate of tax, and then you make a capital gain in that year, then that capital gain is going to be charged at your top rate of tax.”

What are the changes?

Capital gains tax was first introduced in 1985 by Paul Keating under the Hawke Labor government, and was designed to close a major loophole by ensuring profits from selling assets were treated as part of taxable income.

In this first iteration of the system, 100 per cent of the capital gain was taxed as opposed to 50 per cent, but gains were indexed for inflation so people were only taxed on “real” gains.

Current debates on tax reform often speak about returning to indexation over the current flat discount of today.

In 1999, the Howard government scrapped inflation indexation and introduced the 50 per cent capital gains tax discount, making Australia’s CGT simpler — and much more generous.

The new system meant only individuals and trusts who hold an asset for more than 12 months were eligible for the discount and only half the capital gain counted as taxable income.

“What we did have up until 1999 was inflation-proofing by just indexing up the cost base in line with the changes in the consumer price index,” Prof Evans said.

“That changed in 1999 when we brought in the CGT discount. The discount is probably too generous.

“It’s unfair, it’s inefficient, and it costs all of us an awful lot of money to give a benefit to the very few people who make capital gains, only about 10 per cent of people made capital gains.”

It’s understood the Treasury will be most likely lowering the capital gains discount to somewhere between 25 and 33 per cent in an attempt to curb rising costs in the housing market.

Unfortunately, it’s unlikely to “solve” the housing affordability problem, Prof Evans believes.

“Estimates suggest house prices might fall, but only by about one per cent,” he said.

“But it will help, in part by stopping house prices increasing quite so fast as they have since 1999, but more by levelling the playing field and giving first home buyers a better chance of getting a foot on the housing ladder by removing the current very generous tax incentive for property investors. “

What investors should know

While the political debate continues, Prof Evans says investors will still be able to invest in the safe and secure property market.

“Property is always a good investment, with or without tax breaks,” he said. “But inevitably they may lose the tax breaks.”

Those in support of CGT changes have proposed “grandfathering” the changes for existing investors. This will mean those already in the market will be able to keep their tax breaks until they sell.

Prof Evans says investors should focus on the basics of complying with the current rules. The most important step being maintaining accurate records for the Australian Taxation Office.

“They need to know what the asset cost, any expenses they incurred improving or maintaining it, and the eventual sale price,” he said.

Failing to report a capital gain can be costly, particularly as the ATO increasingly uses data-matching to track share and property transactions.

“Don’t assume you’ll get away with it,” Prof Evans said.

“The ATO will probably know you’ve made that gain.”