What is land tax and is it fair?

Why Land Tax is unfair

Property investors are often shocked when they get their first land tax bill. The first question they ask is “what is land tax and why do I have to pay it?” It seems that many accountants discuss federal taxes with their clients but little thought is given to this state based tax.

The amount of land tax you pay is determined by the combined unimproved value of taxable property. It is administered on a state by state basis and is completely separate to other property related taxes: CGT, council rates, income tax and stamp duty.

What often happens is that new property investors buy a house or two and get their first land tax bill before they even realise that they should have considered this tax in their investment strategy. The person who gets impacted the most is the one who buys houses in the same state.

What is land tax and why does it exist?

According to The Economist:

Land value taxation is so beloved of economists because, in theory, it does not distort decision making. Suppose a land value tax of one per cent on land value is introduced tomorrow. There can be no supply response: there would still be as much land as there is today. Neither would consumers’ preferences change, as land would be no more useful, either. So if the market for land is competitive, no transactions would be deterred or encouraged. All that changes is the price, which falls until it exactly offsets the discounted cost of paying the tax forever. The buyer assumes the burden of paying the tax, so all things considered is no better or worse off. Landlords are unable to pass the tax on to tenants, because the supply and demand of rented land is unchanged too. Furthermore, if LVTs replaced property taxes, incentives against improving homes and developing land would be removed. Yet LVT would continue to account for “undeserved” gains landowners make on the investment of others, such as the government improving nearby transport links.”

So, while economists love it and it’s been called “the least bad tax”, is it really fair? I say no, because it may be all well and good in theory, but it isn’t fairly applied. There are ways around land tax: diversification into other states, buy apartments instead of houses, set up one or more SMSFs and various other ownership structures.

Let’s look at 3 investor scenarios:

  1. Owns 3 houses (all investments) in NSW with a combined value of $3M and unimproved land value of $1.5M.
    Their annual land tax bill will be something like $14K.
  2. Owns 3 houses, in different states, with a combined value of $3M:
    1 house in NSW valued at $1.2M, unimproved land value of $600K
    1 house in VIC valued at $1M, unimproved land value of $550K
    1 house in QLD valued at $800K, unimproved land value of $350K
    Their annual land tax bill will be something like $NIL.
  3. Owns 1 house & 2 apartments in NSW with a combined value of $3M and unimproved land value of $1M. Their annual land tax bill will be something like $6K.

Given its origin as a tax of the wealthy, it’s a bit odd that these 3 arguably equally wealthy people get taxed at vastly different rates. Michael Ferella, director of Momenta Advisors weighs into the argument here, highlighting another aspect: “it also doesn’t factor in that you could have two people in scenario 1 with the exact same holdings but vastly different equity yet they still pay the same amount of land tax – at least from an income tax perspective the owner with less equity would have less surplus income and therefore pay less tax, not so with land tax”.

And then there is superannuation. Each self managed superannuation fund (SMSF) gets a brand new threshold, so it’s possible to structure things so that land tax is avoided.

Property investors need to get a return from their investment, or else why bother? Land tax erodes your income, yet it is not a tax that’s based on that income. Bizarrely enough, you get to claim it as a tax deduction… but that hardly offsets the imposition. With rental yields at an all time low in Sydney (sometimes as low as 2%), land tax can easily eat up a large proportion of the rent. It’s not unusual to hear stories of the proportion being as high as 25% of the income. Is this really fair?

Michael Ferella gives us two real life examples that challenge the fairness of land tax:

Example One :

A client purchased a parcel of land (5 acres) approximately 20 years ago which was in a rural area at the time with no sign of infrastructure or investment in the surrounding areas. The goal, hold onto the property until developers come along and acquire the land. Fast forward 20 years the client’s only other property in NSW is their main residence (which is exempt from land tax) however there is more and more development in the suburbs surrounding the land held. The client never built a house on the block nor used the block for agricultural purposes so it has never been income producing. Given the development in the surrounding areas the most recent valuation of the land was in excess of $2m and over the next year or two we are estimating the land tax bill to be in excess of $20k per annum. Given the client earns approximately $120k in salary the land tax bill at 1/6th of their annual income is becoming a massive burden (and note Council rates are also payable on top of this) and the strategy which has been in place for over 20 years to hold out for a developer to come knocking is increasingly in jeopardy due to the Land Tax assessment.

Example Two:

The increasing land tax burden is resulting in the strategy of making non-concessional contributions into super to purchase property via super rather than in individual names ever more popular. This is actually counter-productive on the economy as clients at younger ages are putting their money into super where investments and earnings are only taxed at 15% (10% for Capital Gains) or even NIL tax when in pension mode as opposed to much higher marginal tax rates.

Do investors who favour other investment vehicles have to pay an equivalent tax?

I’ve also asked Michael Ferella to give some perspective on the taxes that apply to other forms of investment. Let’s compare a few as an example to see what taxes are applied:

SharesManaged FundsPropertyBullion
Income Tax on EarningsYesYesYesYes
Capital Gains on DisposalsYesYesYesYes
Stamp Duty (Dis/Acq)NoNoYesNo
Land TaxNoNoYesNo

 

As we can see from the table above, from the four sample asset classes, property is the only asset class where all four taxes are applied.

There you have it. Land tax is an unfair imposition on property investors and it doesn’t even tax property investors equally. If you, like me, are incensed by this, add your voice to the protest and join The Property Investors Council of Australia (PICA) from only $5. This is an organisation that has recently been formed to unite property investors and give us a voice at policy level. It’s much needed!!

References:

Land tax definition:  https://en.wikipedia.org/wiki/Land_value_tax
The Economist:  https://www.economist.com/the-economist-explains/2014/11/10/why-land-value-taxes-are-so-popular-yet-so-rare
Revenue Calculators:  https://www.apps08.osr.nsw.gov.au/erevenue/calculators/landtax.php

Further Reading:

14 Reasons to Think Twice Before Buying a Holiday Home

Emotional property buying mistakes to avoid

Published: 18 September 2018

DISCLAIMER: Good Deeds buyers tips are intended to be of a general nature. Please contact us for advice that is specific to your individual circumstances. You may also need to get advice from other professionals such as an accountant, mortgage broker, financial planner or solicitor.

 

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