Capital gains tax, or CGT, is back in the headlines.
The government is reportedly considering scaling back the 50% CGT discount for assets held longer than 12 months. That’s not small change.
So what could reform actually look like. And more importantly, what could it mean for investors in property, shares and ETFs?
A quick refresher on the CGT discount
Under the current rules, if you hold an asset for more than 12 months, only 50% of your capital gain is added to your taxable income. This applies to investment properties, shares and ETFs.
The original idea was simple. Capital gains are partly inflation. They are also lumpy. Taxing the full nominal gain in one year can push investors into higher tax brackets.
Before 1999, Australia used indexation. Gains were adjusted for inflation instead of applying a flat discount. Now the debate is whether the 50% discount is too generous, and whether it distorts behaviour, particularly in housing.
Scenario 1, the discount is cut for investment properties only
One proposal gaining traction is to reduce the CGT discount only for residential investment property. Economists and Greens senators have floated this option to avoid discouraging investment in other asset classes. If that happens, we could see three effects.
First, property becomes less tax attractive relative to shares and ETFs.
For decades, Australia has favoured property. Negative gearing plus a 50% CGT discount has made leveraged housing investment compelling. If that tax advantage shrinks, the relative after tax return on property falls.
Second, capital could rotate.
Investors are rational. If property after tax returns decline, some capital will flow elsewhere. Listed shares and low cost ETFs are the obvious alternative. They are liquid, diversified and they don’t come with tenant risk, stamp duty or maintenance costs.
That is potentially great for the share market.
More demand for equities can support valuations. It can also support new capital raising. That matters for innovation and growth.
Third, house prices may soften at the margin.
Even modest changes matter. Independent economists have suggested that trimming the discount could reduce house prices by 1.5% to 2%. That is not a crash but it changes behaviour at the margin, especially for leveraged investors.
For long term ETF investors, this scenario is arguably positive. It reduces a structural tax bias toward property and levels the playing field between productive businesses and leveraged housing speculation.
Scenario 2, the discount is reduced for all assets, with grandfathering
Now let’s assume something important.
Existing assets are grandfathered. That means anything you already own keeps the current 50% CGT discount. The new, lower discount only applies to assets purchased after the rule change.
This changes behaviour completely.
Instead of a rush to sell, you would likely see a rush to buy.
A scramble to lock in the old rules
If investors know that assets purchased before a certain date retain a 50% discount forever, that creates a powerful incentive. Buy now. Lock it in.
We saw similar behaviour in past tax debates. Investors value certainty.
In this scenario, you could see increased property transactions before the deadline. Higher equity volumes. Strong demand for ETFs, shares and managed funds. A short term lift in asset prices.
It becomes a classic bring forward effect. Demand that would have occurred over the next few years gets compressed into a few months.
For the share market, that could be supportive in the lead up to implementation. More capital chasing the same pool of listed companies can push prices higher at the margin.
Property and shares both benefit in the short term
If the change applies to all assets, including shares and ETFs, both property and equities could see a temporary demand surge.
Investors who were sitting on cash may decide to deploy it sooner.
High income earners in particular have the most to gain from locking in the higher discount. The difference between a 50% and 33% discount is material at a 47% marginal tax rate.
That can create urgency. Property markets, especially in investor heavy segments, could heat up quickly. Equity markets may see increased flows into diversified ETFs as investors look for simple exposure without stock picking risk.
What happens after the deadline
Once the new rules kick in, the dynamic shifts.
New investments face a lower after tax return. That reduces the long term attractiveness of capital growth strategies relative to income.
You may see greater focus on dividend yield. More interest in franked income. Lower turnover investing. Longer holding periods.
Importantly, existing assets that are grandfathered become more valuable on a relative basis.
An investment property or ETF parcel purchased under the old regime carries embedded tax advantages. That could reduce selling pressure over time. Investors will be reluctant to give up a favourable tax treatment.
This can reduce liquidity in some markets. Fewer willing sellers and tighter supply.
Long term implications for ETFs and diversified investors
For disciplined ETF investors, the impact is nuanced.
If you lock in the 50% discount before the change, you preserve today’s tax settings on that capital base. That’s valuable over decades.
If you invest after the change, the effective tax rate on future realised gains is higher. That increases the importance of tax efficiency.
Low turnover index ETFs become even more attractive in that world. They defer gains. They allow investors to choose when to realise gains. They minimise unnecessary tax leakage.
Active strategies with high turnover may feel the impact more.
The wild card, a return to indexation
There is another path.
Some economists argue we should move away from an arbitrary discount and return to indexing gains to inflation. In a world of modern software and ATO data, this is technically easy. Indexation would tax only real gains. That is economically cleaner and it also reduces distortions between asset classes.
In a low inflation world, indexation and a 50% discount are not that different. In a higher inflation world, indexation could be more generous for long term holders and less generous for short term traders.
For disciplined, long term ETF investors, indexation would likely be neutral to positive compared to a blunt reduction in the discount.
What should investors do now?
It’ important to note that tax reform is political and proposals can shift quickly.
The key is not to overreact.
If changes apply only to property, shares and ETFs could benefit from relative capital inflows. That would be supportive for equity markets over time.
If changes apply to all assets with grandfathering, short term demand could spike as investors rush to lock in the old rules. That may lift both property and share prices before implementation.
But short term demand spikes do not change long term fundamentals. They simply bring tomorrow’s activity into today.
The bigger picture is this: Australia has long skewed incentives toward housing. If reform rebalances capital toward productive businesses, that is healthy for the economy.
For investors, the lesson is unchanged. Focus on diversification. Keep costs low. Stay disciplined. Tax settings do matter… but compounding, asset allocation and behaviour matter far more over decades.
