Rising land tax to cause havoc

Key takeaways

State governments have been sending out land tax notices to property investors recently.

The increased levies are prompting them to reassess their investments.

The surge in land taxes is expected to worsen the rental crisis, as investors may pass on the increased tax burden to tenants, leading to higher rental rates.

Investors should evaluate whether the anticipated future returns justify increased land tax liabilities, and consider geographically diversifying their portfolio to potentially minimize land tax obligations.

State governments' policies, including increased land taxes and compliance obligations, have raised costs and risks for property investors, contributing to the rental crisis.

In recent weeks, state governments have been sending out land tax notices to property investors.

The noticeable increase in land tax receipts over the past few years has prompted more investors to reassess their property investments.

Furthermore, the surge in land taxes is anticipated to exacerbate the rental crisis.

Property investors are likely to pass on a portion of the elevated tax burden to tenants.

Considering the already constrained national rental market, it's inevitable that the land tax hike will contribute to a further rise in rental rates.

For instance, in Victoria, the total land tax revenue has surged by over 300 per cent, jumping from $1.8 billion in the 2016 financial year to a projected $6 billion in the current financial year.

Similarly, the NSW government has experienced a significant increase in land tax, soaring from $2.7 billion in 2016 to almost $7 billion in the present financial year.

Despite this meteoric rise in land tax, the median house gross rental income has only seen a modest increase of around 30%, and house values have risen by almost 45% over the same period.

This indicates that land tax has outpaced the growth in investment returns.

In essence, land tax bracket creep is causing investors to pay a substantially higher amount of tax compared to eight years ago.

Land tax is imposed by state governments, based on the value of land holdings on December 31 each year.

Land tax is a marginal rate system, meaning the more land one owns, the higher the applicable tax rate.

It is calculated based on the unimproved land value assessed by the state’s valuer general, the same valuation used for council rates.

Generally, primary residences are exempt from land tax, but it applies to investment properties and holiday homes.

The rates for land tax differ among states, with many imposing higher rates for properties held in discretionary family trusts.

Property investors are entitled to claim an income tax deduction for land tax paid which effectively means that the federal government picks up some of the bill.

In 2023, the Queensland government swiftly dropped an impractical and unjust proposal to impose land tax on properties situated outside of Queensland.

Victoria, as part of its COVID Debt Repayment Plan, notably implemented a temporary land tax surcharge.

This initiative involved reducing the land tax-free threshold from $300,000 to a mere $50,000!

As a result, approximately 380,000 property investors are anticipated to pay land tax for the first time this year.

These investors will receive their land tax bills this month.

Victoria's new land tax surcharge disproportionately impacts investors with smaller property holdings, leading them to incur significantly higher land tax compared to investors in other states.

For a property with an unimproved land value of $500,000, NSW, Queensland, and South Australia impose no land tax.

Western Australia charges $780, Tasmania $1,850, and Victoria imposes a substantial $1,950 per annum.

According to ATO data, 71.5 per cent of property investors own a single investment property, with many being 'mum and dad' investors on modest incomes.

This means that seven out of ten property investors are likely to own only one investment property.

By levying land tax on holdings exceeding $50,000 in value, Victoria is essentially dissuading 70% of prospective property investors from considering investments in that state.

Many investors have reported that their land tax liability now equates to approximately 10 per cent of gross rental income.

Property expenses, including council rates, insurance, property management, maintenance, and so forth typically amount to 25 to 35 per cent of gross rental income.

Consequently, typically investors are left with only 55 to 65 per cent of their gross rental income to cover higher loan interest costs, creating financial strain on property ownership.

In such circumstances, many investors may have no alternative but to pass on these increased holding costs to tenants.

Regrettably, there are limited options for investors to minimise land tax.

Changing property ownership is often financially impractical, due to stamp duty and Capital Gains Tax liabilities.

Consequently, the decision boils down to either absorbing the higher cost or selling the property.

I suggest that investors evaluate whether the anticipated future investment returns of the property justify the increased land tax liabilities.

For instance, a property projected to provide substantial future capital growth may be worth retaining despite the higher land tax burden.

On the other hand, a property yielding poor returns might be economically unsound, leading investors to consider divesting such assets.

Whenever appropriate, I recommend property investors consider geographically diversifying their investment portfolio, which involves owning properties across different states.

This approach offers numerous advantages, one of which is the potential to minimise land tax obligations.

State governments have contributed a lot to increasing the expenses associated with providing rental accommodations.

Investors are now burdened with higher stamp duty costs due to bracket creep, increased land tax payments, and a multitude of new rental laws and compliance obligations.

This has substantially raised both the cost and risk for property investors.

When we consider how to solve the rental crises, state governments must do their part.

About Stuart Wemyss Stuart was a Chartered Accountant before establishing mortgage broking firm ProSolution Private Clients. He has authored two books and shares his experience with readers of Property Update. Visit www.prosolution.com.au