What is more tax-effective, investing in property or shares?
Many people are attracted to borrowing to invest in property because of negative gearing tax benefits. That is, the (income) loss that an investment property generates helps reduce the amount of tax you pay on your salary or business income. However, investing in shares also offers unique tax advantages. I thought it would be interesting to quantify and compare the taxation outcomes of these two investment options. Taxation of share market investmentsInvesting in shares can result in some attractive tax outcomes. Tax credits Australia’s imputation system, which was introduced by the Hawke-Keating government in 1987, is unique to Australia. It seeks to avoid the double taxation of corporate profits. It does that by giving shareholders a credit (called franking credit) for the tax that the company has paid. For example, if a listed company makes a net profit of $100, it will pay tax at the flat rate of 30%, so its profit after tax is $70. If it pays the profit out as a dividend to shareholders, the shareholders will receive $70 in cash and a franking credit of $30. Therefore, if the shareholder has no other taxable income, when they lodge their personal tax return, the $30 franking credits will be refunded, meaning that shareholder has received $100 in total (being $70 dividend plus $30 tax refund). Therefore, investing in Australian shares which pay franked dividends is particularly attractive to taxpayers that have low tax rates such as super funds, family trusts that have adult beneficiaries with low taxable incomes, and so forth. Even if you are on the highest marginal income tax rate, you are only going to pay 17% of tax on (fully franked) dividend income, because the company has already paid 30%. If you invest in international shares, and Australia has a tax treaty with the country where the shares are listed, you may be able to claim a foreign income tax offset for the tax that you have been deemed to pay in that country. Although, these credits are not nearly as generous as the Australian imputation system. CGTCapital gains tax applies to share investments. If you hold shares for more than 12 months, you will be entitled to the 50% CGT discount, which means only half of the net capital gain will be included in your taxable income. As a rule of thumb, you can calculate your CGT liability by multiplying the net capital gain by 23.5% (being half of the top marginal tax rate including the Medicare levy; 47%). Perhaps the biggest advantages of investing in shares from a CGT perspective is the ability to (1) progressively sell and (2) nominate which parcel of shares you are selling. Selling shares progressively over multiple tax years can help minimise or even avoid crystalising a CGT liability. This benefit cannot be understated. Selecting which method you use to calculate your CGT liability (e.g., FIFO, LIFO, HIFO, as explained here) can also help minimise CGT liabilities. Share investments are very flexible which allows you (or more correctly, your holistic accountant) to proactively minimise your taxation liabilities. Interest and other deductions If you borrow to invest in shares, the interest you pay in respect to those borrowings will be tax deductible, just like it is with property. Therefore, it is possible to negatively gear share investments, although I would caution against doing so (at least not to the same extent as property), aTo subscribe to Stuart's blog: https://www.prosolution.com.au/stay-connected/