State taxes update: What you need to know about the proposed property tax for New South Wales

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A plan to reform property taxes in NSW was cautiously embraced by the media following the release of a consultation paper by Treasurer Dominic Perrottet on Tuesday 17 November 2020. This is what we know so far.

When will it commence?

The proposal is still in its early stages. A consultation paper has been released, with responses due by 15 March 2021. There may be a further round of consultation once draft legislation has been circulated.

The forward estimates for the NSW Budget released on 17 November 2020 do not appear to make provision for the proposed reforms, which is not surprising.  The proposal represents a major tax reform and it is possible a Berejiklian / Perrottet Government may take the proposal to the 2023 state election. That would potentially delay the commencement until the next term of government, if re-elected.

It is expected that property buyers who purchase in the months leading up to the new property tax commencing may be allowed to retrospectively ‘opt-in’ to the property tax and obtain a refund of the stamp duty previously paid.

Stamp duty is here to stay

An important design feature of the new property tax is the ‘opt-in’ mechanism.  This is intended to ensure that people who have already paid stamp duty on the purchase of their properties are not taxed again under the new property tax.

Eligible buyers will be able to choose between paying stamp duty upfront or paying an annual property tax. Once a buyer ‘opts in’ to the new property tax, all future buyers of that property will be required to pay the annual property tax on that property. The consultation paper states that, even after 20 years, the option to pay stamp duty upfront would remain for more than half of all properties in NSW.

Purchase price thresholds may be used to restrict the number of properties eligible to ‘opt-in’ to the property tax. Over time, that threshold may be raised but the consultation paper predicts that initially only 80% of residential properties and 95% of commercial property will be eligible.

Pay upfront or pay later – which is better?

Eligible buyers will be able to work out which form of tax best suit their particular circumstances. The consultation paper suggests that buyers who plan to move home frequently might choose the annual property tax, whereas those planning to buy their ‘forever home’ (where they intend to live for decades) may choose to pay stamp duty upfront.

A range of other factors may need to be considered. For example, the property tax is likely to strongly favour new apartment buyers because the unimproved land value for an apartment is generally disproportionately less than the purchase price. Elderly buyers, on the other hand, may prefer to pay stamp duty upfront so their properties may pass under their will unencumbered by the property tax.

The proposed tax rates are set out in the table below:

Property Type Currently liable to stamp duty? Currently liable to land tax? Potential property tax rate
Owner-occupied residential property Yes No AU$500 + 0.3% of unimproved land value
Investment residential property Yes Yes AU$1,500 + 1.0% of unimproved land value
Investment residential property Yes Yes AU$1,500 + 1.0% of unimproved land value

According to the consultation paper, based on the average unimproved land value for residential property across all of NSW for 2020, the annual property tax for an owner-occupier would be about AU$1,812. For metropolitan NSW (where the average residential land value is said to be around AU$630,400), the annual owner-occupied property tax should be about AU$2,391. 

The calculations may cause some confusion for buyer because the property tax will be imposed on unimproved land values, whereas stamp duty is charged on the improved land value. There is no direct comparison provided in the consultation paper. The following example compares upfront stamp with the annual property tax on a recent NSW property transaction:

Example – freestanding house

A four bedroom house in the NSW suburb of Beecroft sold earlier this month for AU$1,800,000. The stamp duty payable by the buyer is AU$84,005. A search of the Valuer-General’s property register indicates an unimproved land value for that property of AU$1,080,000, which means if the buyer had been able to ‘opt-in’ to the property tax as an owner-occupier (and subject to threshold limits), the annual property tax would start at AU$3,740 (but may increase over time).

Ignoring interest costs and other variables, the buyer would need to pay the annual tax for about 22 years to equal the amount of upfront stamp duty payable. However, it is reasonable to expect increases in the annual tax amount over time (as property values increase), which means it may take significantly less time to exceed the upfront stamp duty amount.

If the buyer of that Beecroft property is an investor, the proposed annual property tax would be AU$12,300. This is compared to upfront stamp duty of AU$84,005 and (assuming the buyer has no other land in NSW) land tax of about AU$5,300 for 2021. If the investor ‘opts in’, the annual property tax replaces both stamp duty and land tax but the investor still seems to pay substantially more than an owner-occupier (approximately AU$7,000 annually). Unlike upfront stamp duties, it is expected that the annual property tax will be tax deductible for investors. But, even allowing for tax deductions, long-term property investors may regard the annual impost as too great.

It is also expected that the proposal may strongly favour buyers of new residential apartment buildings. This may be seen in the following example:

Example – residential apartment

A two bedroom apartment in the NSW suburb of Pyrmont sold in the last month for AU$1,825,000. The stamp duty payable by the buyer is AU$85,380. A search of the Valuer-General’s property register indicates an unimproved land value for that property of AU$534,248, which means if the buyer had been able to ‘opt-in’ to the property tax as an owner-occupier (and subject to threshold limits), the annual property tax would start at AU$2,103 (but may increase over time).

Ignoring interest costs and other variables, the buyer would need to pay the annual tax for about 40 years to equal the amount of upfront stamp duty payable. 

If the buyer of that Pyrmont apartment is an investor then the proposed annual property tax for that investor would be AU$6,842. This is compared to upfront stamp duty of AU$85,380 and (assuming the buyer has no other land in NSW) land tax of AU$0 for 2021 as the unimproved value of the apartment is below the land tax threshold.  It is expected that the annual property tax will be tax deductible for investors.

According to the consultation paper, the proposed tax rate for commercial properties is 2.6% of unimproved land value. At that rate the property tax may accumulate quickly to exceed the upfront stamp duty. The consultation paper also foreshadows the possibility of legislative restrictions on passing on the cost of the property tax to tenants.

It is unclear how the property tax will apply, if at all, to foreign buyers and whether the existing surcharge purchase duty and surcharge land tax may continue to apply to foreign buyers, even if the property has already been ‘opted in’ to the property tax.

The annual property tax will be adjusted periodically as land values change. However, the government is aware that increases based on land values may cause financial stress if land values grow faster than household incomes. One proposal being considered by the government is a mechanism to increase the annual property tax revenue target in line with household income, resetting the rates each year to ensure total revenue is equal to this target (similar to the way local council rates are set).

How will land development be impacted?

There is no mention in the consultation paper of property development. 

Large property developers may be excluded from ‘opting in’ to the property tax under the purchase price threshold. But, subject to aggregation rules affecting the purchase price threshold, it is possible some developers may be able to separately acquire, or accumulate, lots without paying upfront stamp duty. Acquisitions of farmland for future development may also qualify.

However, further details will be needed to determine what happens if land that has been ‘opted in’ to the property tax changes zoning, use or title description. Such changes may affect the tax rate and it is possible the land may be retrospectively excluded from eligibility for the property tax.

We are also awaiting further information as to how the government proposes to deal with partial transfers, dealings with other interests in land and whether the actions of a joint owner or interest holder may affect other owners. The interaction with landholder duty may also need to be carefully navigated.

Should mortgagees be concerned?

The discussion paper indicates that property owners will never be forced to sell their principal place of residence to meet the property tax. Instead, the consultation paper suggests that landowners may be able to defer their liabilities until their financial circumstances improve or until they eventually sell or transfer ownership of the property. This may be a concern for mortgagees particularly if the property tax gives the Chief Commissioner a first ranking charge over the land. Relevantly, the consultation paper states that any outstanding tax would generally be payable as a condition of transfer of ownership.

Lenders may also need to be satisfied that buyers who ‘opt-in’ to the property tax will be able to meet their future liabilities, including any increases as land values rise. However, as mentioned above, the government is considering options to limit tax increases where land values grow faster than household incomes.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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