The federal government is expected to consider changes to the way capital gains are taxed in Australia, with one option being a return to the pre 1999 method of adjusting capital gains for inflation, rather than applying the current 50% capital gains tax discount.
While this may sound like a technical tax change, it could have important implications for investors, retirees, business owners, property owners and families building long term wealth.
At present, individuals and trusts generally receive a 50% discount on capital gains where an asset has been held for more than 12 months. This means that if an investor sells an asset and makes a capital gain, only half of that gain is included in their taxable income.
Under an inflation adjusted model, the calculation would work differently. Instead of automatically reducing the capital gain by 50%, the original cost base of the asset would be increased in line with inflation. The investor would then pay tax on the remaining real gain above inflation.
The key distinction is that the current system generally rewards assets that grow strongly over time, while an inflation adjusted system may favour assets that grow more slowly and broadly in line with inflation. This means the impact would not be the same for every investor, every asset class or every ownership structure.
Why the current 50% CGT discount matters
The 50% capital gains tax discount has been a major part of Australia’s investment landscape for more than two decades. It has influenced how investors think about property, shares, managed funds, business assets and long term wealth creation.
For many investors, the current system provides a strong incentive to hold growth assets for more than 12 months. If the asset rises significantly in value, only half of the capital gain is taxable. This can make long term investment in growth assets more attractive, particularly for people on higher marginal tax rates.
For example, an investor on the top marginal tax rate who realises a $100,000 capital gain under the current system may only include $50,000 of that gain in their taxable income. While the tax outcome depends on their broader position, the discount can significantly reduce the effective tax payable on the gain.
If the current discount were replaced or reduced, investors would need to think more carefully about the type of asset being purchased, the expected return profile, the likely holding period and the structure used to hold the investment.
How an inflation adjusted CGT system would work
An inflation adjusted CGT system aims to tax only the real gain on an asset, rather than the nominal gain.
A nominal gain is the difference between what you paid for an asset and what you sold it for. However, part of that increase may simply reflect inflation. If inflation has reduced the purchasing power of money over time, then some of the increase in asset value may not represent a true improvement in wealth.
Under an indexation style model, the cost base of the asset is adjusted upward to reflect inflation. Tax is then applied only to the gain above that adjusted cost base.
For example, if an investor bought an asset for $500,000 and inflation over the holding period increased the indexed cost base to $600,000, a later sale for $700,000 would result in a taxable real gain of $100,000 before considering any other tax rules.
This approach can be attractive in periods of high inflation, because it recognises that part of the asset price increase may simply reflect the declining value of money. However, it can be less favourable where an asset has grown well above inflation.
The winners and losers may not be obvious
The argument for changing CGT rules is often framed around housing affordability and intergenerational fairness. However, the real impact may be more complicated.
Younger investors are often trying to build wealth from a smaller starting base. They may be more likely to take exposure to growth assets, such as shares, exchange traded funds, technology stocks or higher growth property markets. These are the types of assets that may be disadvantaged if the tax system moves away from a flat 50% discount and toward inflation indexation.
Older investors and retirees, by contrast, may already hold established portfolios with a greater focus on income, capital preservation and lower growth assets. These assets may be less negatively affected by an inflation adjusted model, particularly where the capital growth has been closer to inflation.
This means a change designed to improve intergenerational fairness could have mixed outcomes. It may reduce the tax advantage on some investment properties, but it could also increase the tax burden on younger Australians investing outside property to build wealth over time.
High growth assets could be most affected
The investors most likely to be worse off under an inflation adjusted system are those who own assets that have grown significantly faster than inflation.
The reason is simple. Under the current system, half of the gain is generally disregarded if the asset has been held for more than 12 months. Under an inflation adjusted system, only the inflation component is effectively removed.
For example, if an investment doubles or triples in value while inflation has only increased moderately, the current 50% discount may provide a much better tax outcome than indexation. This is especially relevant for investors who have selected strong performing assets and held them for long periods.
This could have important behavioural consequences. If investors know that high growth assets may attract a larger taxable gain in the future, they may become more cautious about holding those assets in personal names or family trusts. They may also place greater emphasis on superannuation, investment companies or other structures where appropriate.
Lower growth and income focused assets may be less affected
An inflation adjusted system may be more favourable for assets that grow broadly in line with inflation.
This could include certain blue chip Australian shares, income focused shares, infrastructure assets, real estate investment trusts, lower growth property assets and other investments where much of the total return comes from income rather than capital growth.
For example, some Australian shares have historically delivered a meaningful part of their total return through dividends and franking credits, rather than pure capital growth. If the capital growth component is modest and close to inflation, indexation may provide a reasonable outcome.
This does not mean these assets automatically become better investments. It simply means the after tax position may change depending on how returns are generated.
Investors may need to think more carefully about the balance between income and capital growth. Two investments with the same total return may produce very different tax outcomes depending on whether that return comes from dividends, interest, rent, distributions or capital gains.
Property investors may need to review their position
Property is likely to be one of the major areas of focus if CGT changes are introduced.
The current 50% discount has been an important feature of residential property investing. Investors who have held property for more than 12 months have generally been able to discount capital gains by 50% when selling, subject to their personal tax position.
If the system moves toward indexation, the outcome may depend heavily on the type and location of the property.
A lower growth apartment that has increased broadly in line with inflation may be less affected. In some cases, indexation could provide a similar or even better result.
However, a property in a high growth location that has significantly outperformed inflation could face a higher taxable gain under an indexation model. This may be particularly relevant for investors who bought into strongly performing areas years ago and now have large unrealised gains.
Property also creates an additional challenge because the gain is often realised in one transaction. Unlike a share portfolio, where an investor may be able to sell down progressively over multiple years, a property sale usually creates one large tax event in a single financial year.
This makes planning around timing, taxable income, retirement, debt repayment and ownership structure especially important.
Share investors may have more flexibility
Investors with diversified share portfolios may have more flexibility than property investors when managing capital gains.
Shares can often be sold progressively. This may allow investors to realise gains over several financial years, offset gains against capital losses, manage taxable income and avoid unnecessarily pushing themselves into higher tax brackets.
This becomes particularly important for investors approaching retirement. If a client is currently in a high income earning year, it may be less attractive to realise a large gain while their marginal tax rate is high. If they expect to retire or reduce work in future years, there may be an opportunity to realise gains when taxable income is lower.
Of course, tax should never be the only factor. Portfolio risk, diversification, liquidity needs and investment fundamentals remain critical. However, if CGT rules change, the timing of asset sales may become an even more important part of portfolio management.
Ownership structure will become even more important
One of the biggest planning implications is asset ownership structure.
Each structure has different tax outcomes, asset protection considerations, estate planning implications and administrative requirements.
Under the current system, individuals and trusts can often access the 50% CGT discount. Companies generally do not receive the CGT discount, but they may pay tax at a lower company tax rate. Superannuation has its own concessional tax environment, and assets sold in pension phase can generally be tax free.
If the 50% discount is reduced or replaced for individuals and trusts, the relative attractiveness of different structures may change.
For example, an investment company may become more attractive for certain growth assets if the gap between personal tax rates and company tax rates becomes more meaningful. However, companies also have limitations. Extracting profits from a company can create further tax considerations, and companies are not always appropriate for every investor.
Family trusts may also need to be reviewed. Trusts can provide flexibility in distributing income and capital gains, but the benefit of the current CGT discount is an important part of that equation. If the discount changes, the role of trusts in investment planning may need to be reassessed.
Superannuation may become even more valuable as a long term wealth structure, particularly where the asset is intended to support retirement income. However, contribution caps, preservation rules, transfer balance caps and proposed changes to superannuation taxation must all be considered.
The timing of selling assets may become more strategic
If CGT changes are announced, transitional rules will be critical.
Investors will need to know whether any change applies only to new assets purchased after a certain date, or whether it also applies to existing assets. They will also need to understand whether there will be grandfathering, a reset of cost bases, transitional elections or different rules for different asset classes.
Until the final rules are known, it would be risky to make major decisions based purely on speculation. However, investors with large unrealised gains should be aware of the potential issue.
Capital losses may become more valuable
If CGT outcomes become less favourable for some investors, capital loss management may become more important.
Capital losses can generally be used to offset capital gains. They cannot usually be used to offset ordinary income, but they can be carried forward to future years if not used.
Investors with underperforming assets may need to review whether those assets still have a role in the portfolio. If an asset no longer has a strong investment case, realising a capital loss may help manage the tax impact of other gains.
However, this needs to be handled carefully. Selling an asset simply for tax reasons can be a poor decision if it undermines the overall portfolio strategy. There are also rules that can apply where an investor sells and repurchases the same or similar asset mainly to create a tax benefit.
The key is to integrate tax planning with genuine investment decision making.
Retirement planning could be affected
For retirees and pre retirees, CGT changes could have several implications.
Many retirees hold assets outside superannuation, including shares, managed funds, investment properties and family trust investments. These assets may have been built up over many years and may carry significant unrealised capital gains.
If the tax treatment of those gains changes, it may affect retirement cash flow planning, estate planning and the sequencing of asset sales.
For example, a retiree may plan to sell an investment property to fund retirement, downsize, repay debt or help children. If the tax outcome changes, the net proceeds available after tax may be different from what was originally expected.
For share portfolios, retirees may have more flexibility to sell assets gradually. This can allow them to manage taxable income, preserve Age Pension eligibility where relevant and reduce the risk of a single large tax event.
Superannuation remains an important part of retirement planning because of its concessional tax treatment. However, it is not always possible to move large amounts into super due to contribution caps and eligibility rules. This is why early planning matters.
Younger investors should not ignore the issue
Although CGT changes are often discussed in the context of older property investors, younger investors may also be affected.
Many younger Australians are investing outside property because housing affordability has made it difficult to enter the property market. They may be using shares, exchange traded funds or managed funds to build a deposit, create long term wealth or gain exposure to global markets.
If the tax treatment of growth assets becomes less favourable, this may affect how younger investors structure their portfolios. It may also influence the choice between investing personally, using a family trust, building wealth inside superannuation or using other long term structures.
The challenge is that younger investors often have a long time horizon and may naturally be suited to growth assets. A less favourable CGT outcome on those assets could reduce after tax returns, especially where investments are held outside super.
This does not mean younger investors should avoid growth assets. Growth remains important for long term wealth creation. However, the structure, tax position and investment strategy should be considered together.
Business owners may also need to pay attention
Business owners may also be affected by any broader CGT reform.
Many business owners accumulate wealth through business interests, property, trusts and investment companies. They may also rely on the eventual sale of a business or business premises as part of their retirement strategy.
The small business CGT concessions may continue to play an important role, but eligibility is complex and should not be assumed. If broader CGT rules change, the interaction between general CGT rules, small business concessions, trust distributions and company structures may need careful review.
For business owners, planning ahead is critical. Waiting until a sale transaction is already underway can limit the available options.
The importance of advice
Potential CGT reform is a reminder that investment planning and tax planning are closely connected.
The way an asset is owned can be just as important as the asset itself. The timing of a sale can materially affect the after tax outcome. The decision to hold an asset personally, through a trust, in a company or inside superannuation can have long term consequences.
For clients with significant investments, property holdings, family trusts, business interests or large unrealised gains, it is important to seek advice before making major decisions. The wrong move could create an unnecessary tax bill, reduce flexibility or create unintended estate planning issues.
At the same time, doing nothing without reviewing the position can also create risk. Legislative change often highlights problems that already existed in a structure or strategy.
Any change to the capital gains tax discount would represent a significant shift in Australia’s investment landscape. The impact would not be uniform. Some investors may benefit, particularly those holding lower growth assets during periods of higher inflation. Others may be worse off, especially those holding high growth assets that have significantly outpaced inflation.
For many investors, the most important issue will not simply be whether CGT is higher or lower. It will be whether their investment structure, retirement plan, asset sale strategy and tax position remain appropriate under a changing set of rules.
At Cadre Capital Partners, we work with clients to review their investment structures, capital gains tax position, retirement strategy and broader wealth plan. If you would like to understand how potential CGT changes may affect your portfolio, or if you are considering selling an investment property, shares, business asset or other major investment, please contact Cadre Capital Partners so we can help you assess the position before decisions are made.