Unusually this year the Federal Budget includes major changes for investors. Capital gains will be taxed more heavily in some cases and negative gearing of existing properties will be banned. How should they respond?

Currently half of capital gains pass tax free. Only half must be added to the investor’s taxable income with tax paid on that at their marginal rate. In future tax will have to be paid on all gains above inflation at personal marginal rates.

If investments grow slowly little tax will be payable, but if growth is strong, most of the gain will be taxable. Suppose inflation is a steady three per cent per annum. If a property, shares or managed funds grow at three per cent per annum the whole capital gain will be totally tax free.

If investments grow five per cent per annum for ten years $100 initially will be worth $162.88. Inflation will make up $34.39 of that growth. So $28.49 will be taxed. That is 45 per cent of the gain. Currently we pay tax on 50 per cent of gains. The new tax is lower.

What if an investment grows at ten per cent per annum for ten years? An initial $100 will then be worth $259.37. Taking off the inflation allowance will leave $124.98 that is taxable. In this case tax must be paid on over 78 per cent of the gain.

This suggests it will be more tax efficient to buy slower growing investments that pay higher tax-advantaged incomes, especially imputation credits. This will suit retirees.  

Negative gearing of existing residential properties will be banned. Losses on those properties due to expenses such as interest will no longer be deductible against salaries and other income. They will continue to be deductible for all other investments, including new residential properties.

What is a new house? The investor can buy land and build it. They can buy it new from the builder. What if they buy an old house and knock it down and rebuild? If the number of dwellings on the site increases, negative gearing losses will be deductible. If there is no increase, they won’t. 

Importantly this change only affects existing dwellings. Negative gearing continues as usual on all other investments. Wealth accumulators with equity in their own home and surplus income can gear managed funds and shares and claim any income losses against their other income.  

Choosing shares with good growth potential can be very rewarding but isn’t easy. Inexperienced investors can access similar gains by investing in funds run by professional managers. They invest in property, shares and infrastructure in Australia and overseas. Financial advisers can assist.