The new tax rules to apply from July 2027 are changing the way investors think. The most obvious impact is buyers’ recent avoidance of residential property. Values have fallen sharply in many areas.  

The changes are complex so a recap is useful. Capital gains tax (CGT) will apply to gains in excess of inflation with a minimum rate of 30 per cent. Gains up to inflation will be tax free.

Negative gearing of existing residential properties will be banned. Income losses due to loan interest and other costs will not be deductible against other income such as salaries. Self-managed super funds will be entirely banned from borrowing to buy residential property.

Residential properties have been popular investments for many years. Values keep up with inflation due to the limited supply of land, and building costs escalating faster than inflation. Not enough homes are being built to meet demand and house the whole population including immigrants.

Most importantly the gearing commonly used multiplies the capital growth returns. Gearing simply means investing with borrowed money.

Under the new rules, the gearing of property, shares, managed funds and other growth investments will be able to provide gains greater than inflation with no CGT payable. This is because the CGT due is not calculated on the capital the investor outlaid but on the gain in the value of the asset.

For example, it will be possible for an investor to double their investment, make a 100 per cent capital gain, and yet pay no CGT. Suppose a person pays a 20 per cent deposit on a property or share portfolio and borrows 80 per cent.

The value rises by 20 per cent over the next five years in addition to the buy and sell costs. The investor makes a 100 per cent gain on their cash outlay. However the 20 per cent gain on the asset value is likely to be around the rate of inflation, so no CGT will be payable.

If an investor buys an asset with borrowings that grows at the rate of inflation they can make high capital gains and pay no CGT. If the investment also produces enough income from rents or dividends to meet the interest cost of the loan, there will be no net income and so no income tax payable either.

If costs including interest exceed the income, the loss will no longer be tax deductible against other income such as salaries, for residential properties. Losses will continue to be tax deductible against salaries for other investments.

The best investments in the future may be geared ones where the assets grow at the rate of inflation and produce enough income to pay the borrowing costs.