Nick Bruining: Why falling property prices are bad news for new capital gains tax rules

Property investors are struggling to get their heads around next year’s changes to capital gains tax rules, thanks to a combination of the new CGT tax rules and declining property values.

Concerns centre around the minimum 30 percent tax rate and how the gains are calculated, particularly with some recent investors finding themselves immersed in the dark clouds of negative equity.

The silver lining is that declining property values will be locked in next July, possibly resulting in useful capital losses that can be used in future years.

The changes to apply from July next year will see a new method of calculating capital gains liabilities for assets acquired before July 1.

The new rules will also capture previously CGT-exempt assets such as those acquired before September 19, 1985.

Under the changes, investors must value their existing assets as of July 1, 2027. This value will then be used as a cost base to calculate capital gains from July 1 until the date of disposal.

Property expert and valuer Gavin Hegney said many recently acquired properties would be showing a significant decline in value.

“About 40 per cent of buyers before the tax changes were investors and they were big contributors to demand. Essentially, this group has now disappeared,” Mr Hegney said.

“It will depend on where the property is, but some areas that shot up in value over the past couple of years could be looking at declines of up to 20 per cent by July next year.”

For example, an investment property purchased during the boom this time last year for $800,000 may have grown in value up until the May Federal Budget.

Since then, a general decline in values fuelled by the CGT tax changes and rising interest rates may have seen the value revert to the purchase price or in many cases, even less.

If the value falls by 20 per cent to $640,000 by July next year, then that becomes the cost base for the new CGT calculation method. The $160,000 loss in value can be applied against subsequent gains.

In this example, the $640,000 cost base increases on a quarterly basis in line with the published CPI.

Assuming a 3 per cent inflation rate over the following 3 years, the $640,000 July 2027 cost base might increase back to a figure of $700,000 by July 2030.

If the market recovers over the same period and the property is then sold for the original purchase price of $800,000, the assessable capital gain would be the $800,000 sale price, less the $700,000 indexed cost base.

That equates to an assessable capital gain of $100,000.

To that, $100,000 of the calculated July 2027 loss of $160,000 can be applied. That then means potentially, they have a $60,000 loss that could be carried over to be applied in future years.

A similar method applies if a pre-1985 asset is sold after July next year. A valuation needs to be obtained as of July 1 and that becomes the cost base to calculate the CGT liability on a subsequent sale.

The new CGT tax rules raises important considerations for those with pre-1985 CGT-exempt properties.

In some cases, the overall financial viability might be dependent on the CGT exemption applicable under current rules. From next July, capital gains tax applies on the growth above inflation.

“People with inherited CGT exempt assets might find that the after tax return on the capital tied up in that asset might be better off invested into something else, Mr Hegney said.

Assets that generate minimal income but growing in value, are potential candidates.

This could include holdings of vacant land on the fringes of Perth, inherited or acquired when they were classified as rural properties.

Nick Bruining is an independent financial adviser and a member of the Certified Independent Financial Advisers Association