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Thursday, 2 May 2019

2019 may be the last chance to invest tax effectively using negative gearing and the current CGT discount rate

I currently have a relatively modest amount of margin loan debt used to purchase a portfolio of growth assets (some direct investments in managed funds and shares, and some ETF investments in index funds), as I was forced to reduce my gearing during 2008 in order to avoid margin calls, and have taken a more conservative approach ever since.

This will probably change during 2019, as if Labor wins the Federal election (which seems highly probable at the moment) they intend to make massive changes to both the CGT concessional tax rates and the ability to use margin loans and negative gearing to reduce overall taxable income. According to their current policy website:

  • Limit negative gearing to new housing from 1 January 2020. All investments made prior to this date will not be affected by the changes and will be fully grandfathered.
  • Halve the capital gains tax discount for all assets purchased after 1 January 2020. This will reduce the capital gains tax discount from assets held longer than 12 months from 50 per cent to 25 per cent. All investments made prior to the 1 January 2020 will be fully grandfathered.
One positive feature for investors is that investments made during 2019 will still enjoy the current CGT and negative gearing rules going forward. So I'm in the process of transferring $50,000 of my available credit in my St George Portfolio Loan (a home equity loan) into my Commsec Margin Loan account, and I will then purchase $100,000 of growth assets (probably MVW and QUAL ETFs). The dividends from those investments should be less than then interest paid, which under the current negative gearing rules will reduce my taxable income from wage salary etc. When I sell the investments any capital gain will be discounted by 50% before being taxed at whatever marginal tax rate applies to me at the time. If Labor does win the election I'll think about doing the same again before the end of 2019.  While my taxable income will be reduced this year and next by tax deductions for my FP business and self-education costs, in a few years time (all going well) being able to reduce my taxable income may be more important.

A rough calculation shows that investing after the removal of negative gearing would cost me around $3,500 per year more in tax. And that investing next year rather than this year would mean any future capital gain on the investment would be effectively taxed at 75% of my marginal tax rate, rather than the current 50%. (Although this could be managed by only selling a small portion each year after I've retired and receiving a tax-free pension income from my SMSF, so that the CG was subject to nil or low marginal tax rates, in which case the CGT discount rate would not matter).

If nothing else, investing using my margin loan facility after 1 Jan 2020 would make my tax calculations a lot more cumbersome - I would have to keep track of what amount of the loan had been used to purchase investments prior to 1 Jan 2020, and how much afterwards. This could then be used to calculate the proportion of interest paid during the year that could be deducted against other income (eg. salary income) and how much interest was not deductible against other income, but only offset against dividend income. Additional complexities will be introduced if several investments are made after 1 Jan 2020, so the ratio of pre- and post- borrowed/invested funds changed during the financial year. Not to mention if tranches of pre_2020 investments are also sold at different times, and if interest rates have changed during the year

From a financial planning POV, the changes will make Investment Bonds a more attractive option for high income (highly taxed) individuals that are willing to invest for the long term. An investment bond pays tax on earnings at the company tax rate (30%), but benefits from any franking credits (so the effective tax rate is lower). And if held for 10 years or more, there is no tax payable on the gain made when the bond is sold.

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3 comments:

mOOm said...

Interesting to hear that Labor doesn't plan to introduce these policies till the end of the calendar year. I think they will struggle to get some of them through the senate. I've found that my earnings on investments have always been more than the margin interest - but the GFC experience means that I don't gear too aggressively anymore. For me, Labor's proposals have made both superannuation and a company structure more attractive. So, I just made the maximum non-concessional contribution to my superannuation account. I plan to start an SMSF in the new financial year and possibly will bring forward 3 years of contributions for both myself and my wife. I've thought about these insurance bonds. If you are going to retire soon then they probably look less attractive...With a company you could adapt by paying out a salary to reduce the taxable profit?

enoughwealth@yahoo.com said...

I've maxed out my concessionally taxed super (SGL+SS) for many years, but aside from $1000 of non-concessional contributions for the kids and wife (to get the co-contribution) in years where they were eligible (the rules keep changing!) I haven't made non-concessional super contributions (not enough spare cash, unless I sold off my investments outside of super and contributed those funds into super).

Setting up a company doesn't seem suitable to me - my wage salary can't be paid to the company, and even the profits made by my financial planning business wouldn't benefit from the company tax rate, as it falls under the PSI rules and gets treated as personal income (as far as I know - I've yet to finish off all my TBP training to become a financial (tax) adviser).

I think a family trust might be useful, although I don't know much about setting those up, and I think Labor has family trusts in their sights also.

But, as you say, even if Labor forms government, they will have trouble getting some of their tax changes through - given the stated opposition by some independents,

I went ahead and transferred $50K from my home equity loan into my Commsec margin loan account, and bought another $70K of MVW, QUAL, VAS and VGAD.

David Stern said...

Labor plans to tax the income of discretionary trusts at a 30% minimum. If you unitize the trust so that everyone has a fixed share then that should get around that maybe? Anyway, I'm going to do the SMSF first and then get some advice on whether a company or trust might make make sense.