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Tax reform favours apartments and owner-occupiers

The NSW Government is pressing ahead with its proposal for a radical reform of residential property stamp duty, with the recent release of another progress paper. The stakes are high for buyers and sellers in the largest asset class in Australia.

Despite widespread public and media discussion, a major point is overlooked. As proposed, the reform not only treats investors and owner-occupiers differently, but the impact on houses versus apartments is materially distinct. Currently, stamp duty is based on the purchase price and it is the same for a $1 million house as a $1 million apartment, irrespective of who buys it (with some exceptions for first home buyers). The proposal will replace stamp duty with a property tax based on unimproved land value (ULV).

Depending on the location and build quality, the land value of an apartment might be only 5% of the purchase price, whereas the land is often around two-thirds of the value of a house.

For the reform to be revenue neutral, house owners will pay far more and subsidise apartment owners. This must be known to NSW Treasurer, Dominic Perrottet, which means it is a deliberate part of the policy, and begs the question: why is the NSW Government favouring apartments over houses?

The numbers are big. Stamp duty raised $8.3 billion in NSW last year, of which 75% was residential purchases. Stamp duty is the largest source of state taxation revenue after payroll tax.

Australians hold most of their wealth in residential property:

  • Total value of residential real estate: $8.8 trillion (total superannuation assets $3.1 trillion, total value of all listed stocks, $2.8 trillion, total value commercial real estate, $1 trillion)
  • Number of dwellings: 6 million
  • Total mortgage debt: $1.9 trillion
  • Proportion of household wealth held in housing: 54.3%
  • Sales in last 12 months: 592,622 dwellings worth $404 billion.

Source: CoreLogic Monthly Chart Pack, August 2021.

Over the long term, with a few blips, Australian residential property has been a wonderful investment, rivalling shares. Even better, it is easy to leverage into property, creating unbeatable returns on own capital invested. Sydney residents who bought modest three-bedroom homes in the inner west 30 years ago are now wealthy beyond their dreams as their houses now fetch $3 to $4 million.

Source: AMP Capital

What is the stamp duty reform?

The main features of the proposal are to replace up-front stamp duty with:

  • An annual tax based on ULV.
  • At the time of purchase, buyers can choose to pay the annual property tax instead of stamp duty and (where applicable) land tax. From that point onwards, all subsequent owners must pay the property tax and cannot select the up-front option.
  • Price thresholds would initially limit the number of eligible properties to reduce the adverse impact on government revenues. With a desire to ensure 80% of residential properties are eligible, the threshold is likely around $2.5 to $3 million (above which current stamp duty rules will continue to apply).

The proposed annual property tax rate is:

  • Owner-occupied, fixed fee of $400 plus 0.3% of the ULV
  • Investor-owned, fixed fee $1,500 plus 1.1% of the ULV.

In the latest report, Perrottet makes some ambitious claims:

“It would stimulate home ownership, grow the economy and create jobs. It is estimated that, as a result of reform, more than 300,000 NSW residents could achieve their dream of home ownership and Gross State Product could increase by 1.7% ... The proposal, originally outlined in the November 2020 NSW budget, has generated a groundswell of public interest. Over the past six months we have conducted extensive community consultation, hearing from thousands of individuals and hundreds of community and business groups.”

Apartments versus houses

Let’s consider the example of a house and apartment both with a market value of $2 million, and assume the ULV of the house is 66% or $1.32 million but for the apartment it is only 5% or $100,000 (that is, the total value of the land divided among all the apartments according to unit entitlements).

The current NSW stamp duty is the same for both, at $94,862.40 (stamp duty escalates quickly at a marginal rate of 7% over $3,194,000 but this price is not likely to qualify for the reform).

Under the new rules, here are the annual property taxes for these two properties.

Annual property tax for different owners and types of dwelling

Type of owner House Apartment
Owner-Occupier  $    4,360.00  $      700.00
Investor  $  16,020.00  $   2,600.00

That's a range of over $15,000 EVERY YEAR that does not exist at the moment. It does not sound much in the context of the total up front cost of a house, but an investor planning 20 years of ownership might consider $320,000 too much of a burden and opt for the up-front stamp duty. 

Property buying is already an inefficient market. Owner-occupiers borrow at cheaper rates and are exempt from capital gains tax on a principal place of residence. Under current laws, stamp duty is not tax deductible for investors but it is added to the property's cost base for capital gains calculations on sale. Land tax is not deductible for owner-occupiers but it is for investors who earn income from the property. The reform would introduce another set of different annual costs which may distort demand further.

Under the proposal, owner-occupiers and apartments have significant advantages. An annual fee of $16,000 on this house is a hefty 17% of the up-front stamp duty. Hold the property for longer than six years and the stamp duty might be a better option. In this house example, an owner-occupier has an advantage of $11,660 over the investor EVERY YEAR, which is clearly what the policy is aiming to achieve.

And here's a twist. If an owner-occupier buys a house and opts for the property tax, a subsequent investor buyer is stuck with the higher annual tax when they might have preferred a one-off stamp duty. Will investors be discouraged from buying houses where they are forced to pay high property taxes, creating a distorted market? 

Many people buying a house to live in need as much money as possible at the start and most are likely to opt for the annual tax. The average holding period of a home in both NSW and Victoria is about 12 years. 

The policy intentions and distortions are deliberate

The reform would encourage more people to move homes, such as downsizers who have superannuation incentives (eg, a couple can put $600,000 into super) but are discouraged by up front stamp duty. This might have the attractive social consequence of freeing large homes for the next generation of families, and it is preferable if people occupy homes that suit their needs.

Not surprisingly, the peak body that objected to reforms of negative gearing and capital gains tax is backing this change. The Property Council of Australia said in its submission on the proposal:

“Stamp duty distorts business decisions, locks families out of housing choices, worsens housing affordability, suppresses economic activity and leaves governments with highly volatile revenue streams … It is a tax that is a relic from our colonial past, representing a stamp of the state’s authority over property transaction that has absolutely no economic relevance in our modern Australia.”

The latest Government report says:

"Some stakeholders were interested in how the shift to ULV could influence property development. Some stakeholders noted the use of ULV could potentially favour apartment development as it is likely apartment owners would pay less property tax than those that own houses due to the amount of land required for each dwelling."

Specifically, The McKell Institute submission noted (15 March 2021):

“The proposed calculation method on ‘unimproved land value’ would incentivise high-rise development by making low and medium density housing comparatively more expensive. Taxing land rather than capital will encourage substitution of capital for land. In other words, developers will use more capital (building materials, engineering etc.) per unit of land, build up rather than out.”

And the Urban Development Institute of Australia noted (15 March 2021):

“Because property tax is on the unimproved land value, low density homes will pay significantly more property tax than higher density homes in similar locations. This will encourage the construction of more medium density properties. This will be important for planning policies to support this shift, to maintain affordability.”

Some consequences of adoption

The NSW Government hopes home ownership will increase as a prohibitive up front cost would be removed. This should benefit first-home buyers who have had less time and ability to save a deposit. Owner-occupiers are deliberately favoured, and home turnover should increase.

Or is this like many home buyer schemes where the incentives simply lead to higher prices, and nothing is achieved for the buyer? The Government argues:

“While removing stamp duty alone would cause upward pressure on home prices, that pressure would be counteracted under this proposal by the introduction of the property tax.”

I don’t believe that’s how the property market works, at least for owner-occupiers. The reason why residential properties are surging in price at the moment is the ability of purchasers to borrow at low interest rates. Buyers calculate what they can afford, almost irrespective of how expensive homes have become. By taking stamp duty off the table, owner-occupiers can afford to pay more. It's likely owner-occupiers will see the land tax in the same way they see council rates. It’s part of the cost of ownership which has been deeply rewarding for most participants.

And while for social reasons, it’s easy to understand why the Government wants more people to own the home they live in, the policy favouring apartments over housing is more of a mystery. Stopping urban expansion? Increasing density to encourage more affordable housing? This part of the policy is going against the momentum of more people wanting to buy houses and move away from high density dwellings in major cities.

The Government should not assume the switch to a property land tax is best for everyone. It is for an owner-occupier buying an apartment but may not be for an investor wanting a house. And since tax rates and ULVs can rise, a retiree who bought a family home 30 years ago may regret not paying stamp duty up front each time the annual land tax bill comes in.

 

Graham Hand is Managing Editor of Firstlinks. This article is based on a current understanding of the proposal, which may change in final form if adopted.

 

25 Comments
Julie Myers
September 02, 2021

If this goes ahead, properties where owners have opted to not pay the land tax will sell at a premium in the future. Simple maths. So many already work out how to find the 20% deposit to avoid paying mortgage insurance. On going payment of land tax on principal places of residence would force older people with low incomes/pensions out of their family homes to old age homes which have mixed reviews for value and quality. Not sure about the rest of you but I prefer to be within a community of mixed age groups. This tax reform will be another age discrimination event.

If their aim is to increase housing density to reduce infrastructure costs (which I agree they need to do), this reform must be delivered alongside changes to the LEPs. Floor area ratios have been decreasing over the last 20 years. Dual occupancy is not encouraged. If they want higher density make it possible without having to go to the housing commission. Let older people continue to live in their homes but share/rent out part.

Barry Fung
October 15, 2021

In reply to Julie Myers, the proposed Land tax wouldn't affect current houses with elderly occupants but will do future owners who buy choosing the ULV method. Allowing greater land use in LGA zones should be a consideration for house purchasers. In all I see it as a " pay day " loan tax scheme get paid now but you'll be paying forever! Only winner is the government and apartment builders.

Tom Taylor
August 30, 2021

The so called tax reform of replacing stamp duty with an annual land tax is in fact sovereign theft. Brings to mind a quote by ex American president who is now deceased, Ronald Regan" Any time a government official or politician says they are there to help you, just make sure your backside is against a brick wall"

Kevin
August 30, 2021

Let us assume the legislation is adopted. Is it fair to say that any and every single dwelling home that has sufficient unimproved land cannot be refused subdivision approval to develop said land. surely if this were not the case then single dwelling home and land owners would be discriminated against.
If the object of the exercise is to get more people into their own homes why not remove the benefits bestowed on the greedy multiple investment property owners. Own your own home and have one investment property (be it house or apartment) that is tax deductible after that they pay in full for any benefit they achieve.

AlanB
August 29, 2021

Replacing a bad tax like stamp duty with an even worse tax is not tax reform. Look what happened in the ACT when stamp duty began to be phased out 10 years ago. Sine then rates based on land values have gone up 300%. Everyone in my street now pays over $8,000pa in rates. The local goverment also collects more in stamp duty than it did 10 years ago. Of course the Property Council and real estate agents benefit because less stamp duty means more can be paid up front by the buyer for the house and so selling commissions are higher. Overall, property owners come off much worse because there is no escaping the now annual 9-11%pa increase in rates on your home. Unless your income is going up by the same 9-11%pa your living costs are rising faster than your income and your budget will suffer. NSW, don't do it.

Wildcat
August 29, 2021

Why do we still have charts comparing property prices to shares? Share price charts show all capital and market movements. Property price charts exclude contributed capital like redevelopment and renovations and ignore not insubstantial holding costs of rates, insurance and maintenance. It distorts everybody’s understanding of what is really happening.

Ps good article, I was unaware of the bias in the policy towards units and against investors.

Sam
August 28, 2021

Graham,
Any idea about the effective date for this reform?
2022 or earlier?

Doug Turek
August 27, 2021

Looking at the forest rather than the trees, developed-country Governments are addicted, or politically forced, to become big spenders (covid-relief now, climate change & wealth equalisation next). QE/MMT (money printed bond buying) is funding the gap now, but one day the printing presses will run out of ink, so to speak. Then it is back to more taxing. Sadly I think it is inevitable to expect more asset taxing like this, maybe a death Estate Tax or maybe an alive Net Worth tax (latter already applies in Switzerland). At the moment 20% of income tax payers fund the 60% who don't pay income tax. The income tax base is too narrow and getting demographically narrower with an aging workforce. Property taxes are a state tax. An alive or at death wealth tax probably is a Federal Tax. It will be interesting to see how each fight for the right to tax assets, including how long with the Federal Government reduce its tax take by giving deductions for state land taxes? In short, this is innovative, but the design of this is not finished and I imagine one day all properties, and probably all assets, in all states and Federally will be annual value taxed. Its a hard call to say on your next purchase elect stamp duty, because the annual tax will only increase; or elect the annual increase because having paid stamp duty, an annual tax will come anyway? The root of this problem is increased Government spending which the electorate doesn't seem to care much about these days.

M Sum
August 29, 2021

My understanding was Death Duties were a State not Federal Tax.
Is it expected the Federal Government would take this prize.

Trevor G
August 27, 2021

This is pretty scary but not unexpected. Governments have been haemorrhaging cash during the pandemic and racking up huge amounts of debt. Property values are soaring so land tax "reform" is an obvious opportunity to raise more revenue. Thing I don't like about land tax is that (unless you are an investor) there is no underlying cashflow to fund the payment of the tax by the property owner. I own a holiday shack which has gone up in value due to the low interest rates and probably the pandemic too so I'm expecting a land tax hit. You could say that I'm richer due to the value appreciation but its just on paper. I have no intention to sell. Same goes for the primary residence. It's gone up in value but it's our home so we're not going to sell it.

Ish
August 27, 2021

I think the solution to this particular problem is to more accurate reflect the cost of providing services to an area increases based on the occupancy. To this end, the land tax should be increased by 20% for each additional "occupant" of the land, that is, for example, for each apartment built after the first one. This would mean that apartment owners will still pay their fair share of land tax at a minimum of 20% of the amount a house owner would pay.

Charles
August 26, 2021

This policy is so compromised, it seeks to implement multiple objectives. Raising state revenue and also implementing a land use bias and favouring a particular type of buyer. It distorts the market and may result in socially undesirable and unpopular results. eg. High density housing is currently out of favour in the covid pandemic. Home schooling encourages demand for houses with more space. Lockdowns encourage demand for back yards.
This looks like the property industry in NSW has drafted this policy. Undue influence?
Like all policies with multiple objectives it is a compromise and will not optimise outcomes. At the very least it will distort the market with medium and long term consequences and costs which will be difficult if not impossible to unwind.
It is likely to encourage investors to move capital across state borders seeking a more favourable tax regime. This flight of capital is seen overseas. eg. The US where people move between states and districts based on property taxes.

The NSW Government would be wise to seek broader advice that it appears to have at present.

Stephen
August 26, 2021

For an example of the phasing out of stamp duty in Australia please research the experience in the ACT. Yes stamp duty receipts are roughly level since 2012 but the ACT government’s tax take has more than doubled since then. Rates have gone up well above inflation. The increase in rates is unrelated to the underlying costs of providing services normally associated with rates and acts as a de facto land tax on all property owners in the ACT. Although rates are a local council responsibility in NSW I suspect the same will happen here. It is just a tax increase passed of as “reform” that favours vested interests.

Sean Anderson
August 26, 2021

I think what also can't go without saying is that this provides a smoother, annuity style income for the state government. It won't have to deal with the swings and roundabouts of the property cycle. Some of the biggest costs to the state government are hospitals, education, transport. Being able to rely on guaranteed funding I think will be a good thing.

Brian Menzies
August 26, 2021

Do I understand correctly, please?
Will I have to pay Land Tax on an existing fully owned house property?
Is my existing home exempt from Tax because I paid Stamp Duty when I purchased it?
If a property is purchased under the proposed tax changes and the buyer elects the Land Tax option does that mean that property will be forever classified as paying Land tax regardless of how many times it changes hands?
Thanks

Graham Hand
August 26, 2021

Hi Brian, so this is a proposal at this stage, but if adopted:
1. No, you will not receive a new land tax bill on your existing home, this is only for new purchases after adoption.
2. Yes, once any buyer elects the land tax option, the property will forever retain this treatment.

Brian Menzies
August 26, 2021

Thank you

Ron
August 26, 2021

Graham, I am no friend of big developers but even I would not accuse them of such outrageous profit margins. If a block of 200 apartments has an average unit value of 2 million dollars and the construction and marketing costs averaged across 200 units is certainly well south of half a million then I suggest that is the explanation why Harry Triguboff is so rich.
I am not a quantity surveyor but my guess is the the land value in the average unit in your example would be more than $500,000 thus levelling the playing field for owner-occupiers..

Graham Hand
August 26, 2021

Hi Ron, Thanks for the comment ... I didn't say the average apartment cost was $2 million, I said assume there is an apartment worth $2 million in a large building. In a large building of say 200 units, there may be a one-bedder on the first floor worth $500,000 all the way to a four-bedder penthouse worth $5 million (or if it is Crown at Barangaroo, $20 to $60 million). The total value of the land is allocated according to unit entitlements (size), giving the penthouse the biggest bill. So my example is an apartment somewhere in this building worth $2 million with $100,000 of the total land value allocated to it. Every building is different but this is typical in my experience of owning a few apartments.

Dt
August 26, 2021

Ron, both you and Graham are a long way off the mark. The average land value per unit on a 200 site is $45-$50k.

Graham Hand
August 26, 2021

Thanks, Dt. So Ron is saying I underquoted and your are saying I overquoted, so I might be about right. But bowing to your knowledge, then it makes my point even stronger.

Ron
August 26, 2021

Hi Dt,
You sound confident. Perhaps you could solve a long standing mystery for me and reveal what the construction cost of an average unit in the hypothetical 200 unit development with a $45-$50k per unit land cost in an average suburb and with what selling price. Thanks.

Sid
August 29, 2021

Ron - the cost of construction of most multi-unit developments has remained at $3,000 per sqm for some years though it may be a tad higher of late with recent, though possibly transitory, input price increases. There are other costs like funding, permits, legal etc. The land underneath is the major variable, as well as the price people are willing to pay for the finished article in low interest rate conditions like these. People will pay $12,000+ per sqm in Sydney, and it’s not uncommon for prices nearer $20,000 psqm in well located areas.
Hence, there’s a lot of money being made by well organised developers in this market.

John
August 26, 2021

Just remember, whenever the government proposes "tax reform" remember it means that you will be paying more tax (in the long term). The government likes tax reform that it can sell as a tax reduction, but remember it will always mean us paying more tax

Marty
August 25, 2021

Great thoughts Graham.
The proposed property tax appears likely to be tax deductible for investors so they won't mind the relative higher tax to owner-occupiers as much.

However, ULV is likely to increase in the long term and hence property taxes will likely increase although the tax includes a proposed cap on the annual increase.

If a purchaser had enough money for the transfer/stamp duty but chose the property tax, it could be worthwhile investing the difference in the first year and the property tax could be paid by the investment returns.

 

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