Changes announced in the May Federal Budget will significantly alter how capital gains tax is calculated on investment properties from 1 July 2027.

Under the proposed reforms, the existing 50 per cent capital gains tax discount will be replaced by an inflation-indexation method for gains arising after that date. A minimum tax rate of 30 per cent will also apply under the new arrangements.

For investors who already own residential or commercial property, this creates an important planning opportunity. Obtaining a formal market valuation around 1 July 2027 may help establish how much of a future capital gain relates to the period before the new rules commence and how much relates to the period after them.

A robust and defensible valuation could materially reduce the capital gains tax payable when the property is eventually sold.

Why a property valuation may be required

Where an investment property is acquired before 1 July 2027 and sold after that date, the capital gain may need to be divided into two components.

The first component relates to the increase in value up to 1 July 2027. This portion may continue to be assessed under the existing capital gains tax rules, including access to the 50 per cent discount where the property has been held for at least 12 months.

The second component relates to the increase in value after 1 July 2027. Under the proposed rules, the property’s value at that date would become the starting point for calculating the later gain. That value would then be indexed for inflation until the property is sold.

A market valuation therefore creates a reference point between the old and new tax systems.

This applies to both residential and commercial investment properties.

How the new calculation may work

Consider an investor who purchased an investment property for $800,000 in 2018 and sells it for $1.8 million in 2033.

Assume the property is independently valued at $1.4 million on 1 July 2027.

Gain arising before 1 July 2027

The increase in value from the original purchase price to the 1 July 2027 valuation would be:

• Original purchase price: $800,000
• Market value at 1 July 2027: $1.4 million
• Capital gain attributable to the pre-2027 period: $600,000

Assuming the investor qualifies for the 50 per cent capital gains tax discount, the taxable capital gain would be reduced to $300,000.

For an investor on the top marginal tax rate of 45 per cent plus the 2 per cent Medicare levy, this would result in tax of approximately $141,000.

Gain arising after 1 July 2027

The $1.4 million valuation would then become the starting cost base for the post-2027 period.

Assume total inflation between July 2027 and the sale in 2033 is 15 per cent. The inflation-adjusted cost base would be:

$1.4 million × 1.15 = $1.61 million

The post-2027 capital gain would therefore be:

• Sale price: $1.8 million
• Indexed cost base: $1.61 million
• Post-2027 capital gain: $190,000

At a 47 per cent marginal tax rate, the tax on this component would be approximately $89,300.

The total estimated tax across both periods would therefore be approximately $230,300.

The outcome will depend on the property’s valuation, future inflation, the sale date, the investor’s tax rate and the final form of the legislation.

Why the valuation can make a material difference

The proposed reforms may produce different outcomes depending on when the property’s growth occurred.

Where a significant portion of the property’s appreciation happened before 1 July 2027, a formal valuation may allow more of the total gain to be assessed under the existing rules and potentially qualify for the 50 per cent discount.

Where inflation is high and the property is held for a long period after July 2027, the indexation method may also provide a meaningful increase to the property’s cost base.

However, where inflation is low or the property is sold soon after the new rules commence, the existing 50 per cent discount may have produced a more favourable outcome.

The valuation preserves the ability to compare the available methods when the property is ultimately sold.

When should the valuation be completed?

Investors do not necessarily need to arrange for the physical valuation to occur on 1 July 2027.

A qualified valuer may be able to prepare the report after that date and assess the property’s market value retrospectively as at 1 July 2027.

However, investors should not leave the process too long. The further the valuation date moves into the past, the more difficult and expensive it may become for the valuer to obtain reliable supporting evidence.

Investors should consider contacting a valuer in advance to confirm availability and understand the information that will be required.

Completing the valuation within a few months of 1 July 2027 may make it easier to obtain a reliable assessment and retain appropriate evidence of the property’s condition at the relevant date.

Who should carry out the valuation?

The Australian Taxation Office has not yet finalised the specific valuation requirements for the new capital gains tax rules.

However, existing ATO guidance generally requires tax-related valuations to be objective, evidence-based and capable of being supported if reviewed.

For this reason, investors should consider using an appropriately qualified and experienced property valuer.

A valuation obtained for bank lending purposes may not be sufficient. Bank valuations are generally prepared to assess the lender’s security position and may be conservative. They are not necessarily designed to establish a market value for capital gains tax purposes.

A professional valuation is likely to provide greater credibility and a stronger evidentiary record if the ATO reviews the calculation in the future.

What should a valuation report contain?

The purpose of the valuation is to establish a supportable market value as at 1 July 2027.

Ideally, the valuer should physically inspect the property and prepare a detailed report explaining how the market value was determined.

A comprehensive valuation may include:

• details of the property and its condition;
• photographs taken at or around the valuation date;
• recent comparable property sales;
• local market conditions;
• rental income and lease terms;
• zoning and permitted uses;
• land and building details;
• improvements and renovations;
• occupancy information;
• property outgoings;
• the valuation methodology used; and
• the valuer’s qualifications and professional opinion.

A physical inspection may provide stronger evidence than a desktop valuation based only on online property data.

Additional considerations for commercial property

Commercial property can be more complex to value than residential property.

Residential properties often have a larger number of comparable sales, particularly in established suburbs with relatively similar homes or apartments.

Commercial assets are often more specialised. Their value may depend on factors such as:

• lease duration;
• tenant quality;
• rental escalation clauses;
• vacancy risk;
• permitted use;
• location;
• building condition;
• development potential;
• market yields;
• operating expenses; and
• the strength of the local commercial property market.

Specialised properties such as medical centres, childcare facilities, service stations and purpose-built industrial sites may require more detailed analysis.

Commercial property owners should retain lease agreements, rent statements, operating expense records and other financial information relevant to the valuation date.

What records should investors retain?

A valuation may not be required until many years after it is completed, when the property is eventually sold.

Investors should therefore maintain a permanent and organised record of the valuation and its supporting documents.

Relevant records may include:

• the signed and dated valuation report;
• the engagement letter;
• the valuer’s invoice;
• photographs of the property;
• comparable sales evidence;
• rental statements;
• lease agreements;
• property management statements;
• council and water rates;
• land tax assessments;
• records of renovations and improvements;
• construction invoices;
• depreciation schedules;
• legal and acquisition costs; and
• ownership and settlement documents.

These records may be essential if the valuation or capital gains tax calculation is reviewed by the ATO.

Avoid inflated or unsupported valuations

A higher 1 July 2027 valuation may reduce the portion of a future capital gain assessed under the new rules. However, investors should not attempt to artificially inflate the property’s value.

The valuation must reflect a genuine and defensible market value.

The ATO has access to extensive property data from councils, state valuation authorities, commercial property databases, previous tax returns and transaction records. Data analytics may also be used to identify valuations that appear inconsistent with broader market evidence.

Where an unsupported valuation is rejected, the investor may be required to pay additional tax, interest and penalties. Their future tax affairs may also attract greater scrutiny.

The objective should be to obtain the highest supportable market value, not an artificially inflated figure.

How much could a valuation cost?

The cost will depend on the property’s type, location, value and complexity.

Indicative fees may include:

• residential property valued at up to $2 million: approximately $700 to $1,200;
• residential property valued between $2 million and $10 million: approximately $1,200 to $4,000;
• commercial property valued at up to $2 million: approximately $1,100 to $2,000;
• commercial property valued between $2 million and $10 million: approximately $2,000 to $6,000; and
• specialised commercial property: approximately $3,000 to $10,000.

Valuation costs are currently generally tax-deductible where they are incurred in managing an investment property, although investors should confirm the treatment with their tax adviser.

The alternative ATO apportionment method

Investors may also be able to use an ATO-prescribed apportionment method rather than obtaining a formal market valuation.

Although the final formula has not yet been released, the proposed approach is expected to allocate the total capital gain evenly over the period the property was owned.

For example, assume an investor purchases a property in 2020 and sells it in 2030 for a total capital gain of $1 million.

Under a time-based apportionment method, approximately $100,000 of the gain would be allocated to each year of ownership. This may result in:

• $700,000 being attributed to the period before July 2027; and
• $300,000 being attributed to the period after July 2027.

However, property values rarely increase evenly each year.

Where most of the property’s growth occurred before July 2027, an independent market valuation may produce a more favourable outcome than a simple time-based formula.

Conversely, the ATO formula may provide the better result in other circumstances.

Investors may be able to compare both methods when the property is ultimately sold and use the method that results in the lower capital gains tax liability, subject to the final legislation and ATO guidance.

Why investors should consider obtaining a valuation

It is impossible to know today how much a property will increase in value after 1 July 2027 or when the owner will ultimately decide to sell.

Obtaining a valuation preserves an additional calculation option.

Without a formal valuation, the investor may be required to rely on the ATO’s default formula, even where the property experienced substantial growth before July 2027.

While arranging a valuation involves time and expense, a credible report could ultimately save a property investor tens or even hundreds of thousands of dollars in capital gains tax.

Financial planning considerations

The capital gains tax changes should not be considered in isolation.

Property investors should also review:

• their expected investment timeframe;
• future retirement dates;
• their marginal tax rate in the expected year of sale;
• ownership through personal names, trusts, companies or superannuation;
• debt and cash flow;
• potential property improvements;
• estate planning arrangements;
• succession planning for family or commercial property;
• the timing of any proposed sale;
• superannuation contribution opportunities;
• the interaction with land tax and income tax; and
• whether the property continues to support their broader financial objectives.

A valuation does not require an investor to sell the property. It simply helps preserve the information required to assess the available capital gains tax methods in the future.

As the reforms approach, investors should coordinate their financial adviser, accountant, tax adviser and property valuer to ensure the appropriate records and strategies are in place.

Contact Cadre Capital for support reviewing how the proposed capital gains tax changes may affect your investment property strategy and broader financial plan.