The existing tax structure prompts ordinary investors to amplify their borrowing in an inefficient manner to generate tax losses. This strategy, which is common among Australians aiming to increase their wealth, shows how investors are rewarded for greater leverage.
The Labor government has signalled a willingness to reform the tax system, potentially diminishing the appeal of such strategies by lowering the CGT discount on property sales. A recent study by the e61 Institute analysed a vast dataset of 900,000 property investments from 2008 through 2025. It found that 46,000 of these investments had before-tax returns that fell below prevailing mortgage rates. Remarkably, these investments nevertheless turned profitable post-tax due to the fixed 50% CGT discount.
In essence, landlords in the highest tax brackets can offset their losses at a rate of 45% while only taxing their gains at 22.5% due to this discount, as explained by e61 Research Manager Dr Nick Garvin. The research indicates that for the average investor, the tax rate on total housing returns decreases as loan-to-valuation ratios increase, which incentivises leveraging more funds.
Historically, increasing leverage has resulted in greater exposure to capital gains, albeit at the cost of increased interest payments. Ultimately, the tax owed on capital gains tends to be less than the deductions received for higher interest expenses. This creates a scenario where investors are motivated to maximise their borrowing, subsequently contributing to upward pressure on property prices.
Dr Garvin stated, “By borrowing more, investors can benefit from tax deductions that surpass the discounted tax rate.” He added that when leveraging reduces tax liabilities and can convert pre-tax losses into gains, it encourages individuals to expand their investments in assets that generate capital gains. This tendency often leads to inflated asset prices, particularly in housing, pushing households towards riskier and less diversified portfolios than they might otherwise choose in the absence of such tax incentives.
Dr Garvin advocates for reforms aimed at either reducing or eliminating the incentives for excessive borrowing, suggesting a return to a taxation system where investors are taxed on an inflation-adjusted basis rather than a fixed discount. This approach would ensure every investor pays tax on their real gains without advantage from discrepancies.
The new Shadow Treasurer Tim Wilson has expressed a willingness to consider Labor’s efforts for substantial tax reform, following his colleague Andrew Hastie’s appearance on ABC’s Insiders, where he appeared open to revisiting CGT discount policies. Hastie remarked on the necessity of comprehensive reform, stating, “We need to fix the system or risk its dismantling.”
Wilson acknowledged that there are significant challenges facing the country that necessitate visionary thinking. Support for the recent parliamentary inquiry report indicates a consensus among Labor members about the CGT discount exacerbating generational inequality within the housing market. The report stated that the advantages of the capital gains tax discount are inequitably distributed, with far-reaching implications for income, wealth, and intergenerational inequality.
Additionally, research from the Parliamentary Budget Office has estimated that the capital gains tax discount, along with negative gearing deductions for investment properties, could cost taxpayers over $24 billion each year over the next decade.
In conclusion, as the federal budget approaches, the Labour government may implement reforms to address issues related to capital gains tax and its impact on the housing market, with potential long-term implications for tax equity and housing affordability.
