Australian expats could see a jump in tax liability on the sale of their Australian homes under new housing affordability laws the government is considering.
Home owners who sell while they’re living overseas could lose the capital gains tax exemption on a home which used to be their main residence in reforms targeted at foreign investors to “safeguard the opportunity for Australian buyers to purchase,” according to budget papers.
The reforms are part of a host of changes to policy investment rules aimed at improving housing affordability, announced as part of the 2017-18 Federal Budget in May. And the details of the capital gains tax reform were released in July in an exposure draft inviting submissions.
Under current laws, Australian residents get a full exemption from capital gains tax on the sale of a home that was their main residence throughout the ownership period. Capital gains tax is a tax on the profits earned on an asset in the time that a person buys then disposes of it. It’s not a separate tax but rather the capital gain is included in a person’s taxable income in the year when the sale was made, then calculated as part of income tax.
Australian residents also receive a partial exemption if the home was their main residence for only part of the ownership period. And they benefit from an “absence rule,” which allows them to treat a dwelling as their main residence for capital gains tax purposes for an unlimited period of time, as long as they keep it empty and don’t rent it out.
Australians who move overseas for work opportunities can qualify as “non-tax residents,” effectively removing their Australian tax liability for the period they live abroad. It is this group of Australian citizens most likely to be affected by the changes to capital gains tax rules if they own an Australian home, as the new regime will not longer grant them the “absence rule” nor will it offer a partial exemption for the period during which their home was their main residence.
Tax changes for foreigners who own in Australia
Temporary tax residents–residents who hold a temporary visa–who own property in Australia and use it as their main residence will keep the current capital gains tax exemption, as long as they are not foreign residents at the time they dispose of the property.
But among the affordability measures are other rules that will affect foreigners who hold Australian property. These include the introduction of an annual “ghost house” levy for foreign owners of Australian property in cases where the property is neither occupied or genuinely available for rent for at least six months of the year.
A non-final withholding tax on payments made to foreign residents who dispose of taxable Australian property has been increased from 10% to 12.5% of the sale value, and its threshold lowered from only affecting properties valued above $2 million to a $750,000 threshold.
The government will also remove a number of deductions commonly used by overseas investors to reduce the tax bill on a property, including travel expenses related to inspecting, maintaining or collecting rent for a residential rental property. Inspection costs by third parties will still be deductible.
Backlash to the proposed changes
PricewaterhouseCoopers has warned that the proposed measures reinstating capital gains taxes may make it harder for employers to get Australians to accept overseas assignments. Employers may also have to consider the effect on tax equalization arrangements for their staff, where salaries and bonuses are adjusted to the tax regime of another country to ensure the employee earns the same net yearly amount.
Mark Molesworth, a tax partner at BDO, an association of independently owned accounting practices said the measures will have an unreasonably sudden impact on the tax status for owners of Australian homes.
“It doesn’t seem fair to me that someone who has owned their main residence for the last 30 years pays tax on the full gain of those last 30 years because they became a non-resident a few days or a week before the time they sell it,” he said.
“That seems like an overly severe outcome from what they are trying to achieve from this policy.”
Mr. Molesworth provided a hypothetical example of how the legislation would affect someone who owns a Sydney house worth A$2.5 million (US$1.99 million), having climbed from its $500,000 purchase price in 1990–a reasonable proposition for an inner city home given Sydney’s house price growth in recent decades.
A husband and wife buy the house and raise children there, then move overseas in December 2019 for a job opportunity after the children have grown up and moved out. They sell it in January 2020, after the tax exemption is no longer in effect, for $2.5 million after a period of negotiation.
“Assuming that they became non-residents of Australia on Jan. 1, 2020 they will pay tax on the full $2 million capital gain, despite only having been non-residents for two weeks at the time that they sell.”
He thinks a fairer approach would be to tax the capital gain proportionately based on the period of non-residency as a fraction of the entire ownership period, rather than looking simply at whether someone is a tax resident at the time a contract is signed.
He is not the only economist who believes this is an unfair approach. Saul Eslake, an independent economist and regular government adviser, also believes the simple test of whether someone is a resident or not at the time of sale is unfair.
“If someone lives in a house, has a house they bought nine years ago and after nine years of living in it, goes overseas for a few years, then if they have to pay capital gains tax without having a deduction for the interest they have paid during time they bought it, that, to me, would be very unfair,” Mr. Eslake said.
Housing affordability is an increasingly heated issue in Australia. The latest Demographia International Housing Affordability Survey found Sydney was the second least affordable major housing market behind Hong Kong, and all five of Australia’s major housing markets were “severely unaffordable.”
Sydney house values have risen by a cumulative 110% since 2009, while Melbourne values are up 101%, according to data company CoreLogic.
The proposed amendments apply to properties purchased from budget night, May 9, however owners of property purchased before that time would have until June 30, 2019 to sell before losing the exemption.
As it stands now, the capital gains tax exemption doesn’t just apply to the main residence. Investors who hold a home for more than 12 months, which isn’t their main residence are entitled to a 50% deduction on their capital gains tax. However investors who are non-residents are not entitled to this discount.
A poll by the Economics Society of Australia Monash Forum found leading economists were divided on whether the capital gains tax discount should be kept, with 44% believing it should be removed entirely.
And the capital gains tax exemption is just one of a number of generous tax incentives for owners of Australian property. Tax breaks for “negatively geared” properties allow homeowners to claim a tax deduction against their other income for losses made on a property where expenses, including interest repayments, are higher than incoming rent.
Mr. Eslake believes generous tax incentives are a significant factor in Australia’s housing affordability crisis, and the problem will remain as long as the government continues to shy away from reforming controversial items like the capital gains tax exemption and negative gearing.
“These changes, while I’m not opposed to them, are just sort of nibbling around the edges,” Mr. Eslake says.
“It seems the only property investors the government is willing to make life a bit more difficult for are foreign ones. The government is bending over backwards to retain the privileges for what it describes as ‘mum and dad investors trying to get ahead’. And it is confining any measures designed to reduce the attractiveness of property investment to foreign investors, presumably because they don’t vote.”
Australian Treasurer Scott Morrison’s office did not reply to a request for comment.
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