There’s a better way to cool off the housing market

The elephant in the room, when the Treasurer was formulating this year’s budget, must have been the overheated Australian residential property market, and how it was becoming increasingly unaffordable for younger Australians to buy their first home.

The problem is what do you as the Treasurer do when the stated policy of your party is not to scrap negative gearing? When you combine the affordability issue with the revenue loss associated with negatively geared residential properties a solution had to be found.

This turned out to be one of the surprises in Scott Morrison’s second federal budget, a tightening of tax deductions related to rental properties. What the legislation looks like after it has gone through the political process in Canberra will be anyone’s guess.

Under the policy announced on budget night, said to be an integrity measure to fix a situation where plant and equipment is being depreciated by successive investors for in excess of their actual value, restrictions will be placed on what can be claimed as a tax deduction for depreciation on plant fittings and equipment included in residential rental properties.

When an investor wants to maximise tax depreciation claims for a residential rental property, a depreciation report is obtained from a quantity surveyor. Under this process the quantity surveyor places a value on the market value of fixtures, fittings, equipment and plant at the date of property purchase.

As a result of the depreciable assets included in a property purchase being revalued by a quantity surveyor, and because the written down value of the assets purchased with the property not being taken into account, the actual cost of the assets being depreciated can end up being higher than the original purchase cost.

The measure will apply only to residential investment properties purchased after 7:30 PM on May 9, 2017, that are not new constructions. Depreciation of fixtures, fittings, equipment and plant will still be allowed when an investor buys a property from a developer, or they build the property themselves.

When an investor replaces fixtures and fittings and other depreciable assets after the purchase of the property they can depreciate the cost of those assets.

For non-new residential properties purchased the value of the fixtures and fittings and other depreciable assets will form a part of the cost base of the property for capital gains tax purposes.

What does not appear to be a part of the new policy is a restriction on the deductibility of capital works deductions. The ability to claim a tax deduction for the construction and other capital costs of a residential property was introduced in the mid-1980s.

This was done at a time when the construction industry was in decline and housing rental stocks were much reduced. These problems arose partially due to the recession we had to have, and the last attempt by a federal government to constrict the tax benefits of negatively geared properties.

If the Treasurer is really concerned about taking the heat out of the residential property market, and also reducing some of the revenue leakage associated with negatively geared properties, I would not be surprised to see the deduction for capital works being limited in future to new properties.

Rather than outlawing negative gearing altogether, or placing a limit on the amount of loss that can be offset against other income, such as exists in the US tax system, a policy restricting the tax deductibility of construction cost to new properties would make sense.