Paying tax is psychologically painful. Loss aversion means we experience losses about twice as strongly as equivalent gains, and this effect is amplified when we pay expenses. Governments are widely seen as wasteful with public money, and that perception is largely justified. Virtually every taxpayer shares the view that too much of what they contribute is squandered. No one enjoys handing it over.
But tax is only one consideration among many, and rarely the most important one. For investors, over-fixating on it is a genuine risk. The drive to minimise tax can lead to decisions that are far more costly than the tax itself.
What the numbers show
To understand the real impact of capital gains tax, I ran financial projections modelling the internal rate of return for both property and shares under different tax scenarios.
For property, I assumed the investor borrows to invest, holds for 30 years, then sells and pays capital gains tax in full. For shares, I assumed $5,000 per month invested into a portfolio over 30 years, then sold in one transaction. Selling a share portfolio in one hit is almost certainly unrealistic, because one of the key advantages of shares is the ability to sell progressively and spread the capital gains tax liability across multiple financial years. But it serves as a useful stress test.
The core insight is that changes to capital gains tax have a surprisingly modest impact on the internal rate of return. The difference between current law and a return to the old indexation system, for example, is just 0.8% over 30 years.
What actually drives returns is twofold. First, gearing. Borrowing to invest magnifies positive returns, and that effect dwarfs most tax considerations. Second, the underlying performance of the asset, which, combined with gearing, accounts for most of the return.
One result worth highlighting: when I modelled a scenario where tax is eliminated entirely, the internal rate of return fell, which might seem counterintuitive. The reason is that negative gearing delivers substantial tax deductions throughout the holding period, and those deductions are worth more than the capital gains tax liability at the end. This has an important implication for policy. If the government were to change how property investment is taxed, a change to negative gearing would be far more damaging to investors than a change to capital gains tax.
For shares, the tax impact is more pronounced for two reasons. First, I have assumed that the portfolio generates relatively little income or capital gains during the holding period, so the ongoing tax consequences are low (which is realistic for a well-structured and managed ETF portfolio), but the CGT full liability crystallises in a single year when the portfolio is sold. Second, and perhaps more significantly, there is no gearing. Without borrowings, there is nothing magnifying returns the way leverage does in the property scenario, which means tax has a proportionally larger effect on the overall outcome.
Ownership structure: the tax decision hiding in plain sight
What this analysis ultimately highlights is that investment ownership structure is a very important decision.
When borrowing to invest in property, the two tax factors that typically matter most are negative gearing and land tax. Negative gearing is particularly valuable for high-income earners – a dollar saved today is worth far more than a potential reduction in capital gains tax 30 years from now.
A current client example illustrates this well. We have been working with a client who intended to Airbnb their property. Given the strong after-expense income that this property was expected to generate, we structured most of the asset in the spouse’s name to manage the taxable profit. They are now reconsidering that Airbnb plan, and if the property becomes negatively geared, it may make more sense to hold it in the higher-income earner’s name to maximise the tax deductions. Changing the ownership structure would trigger stamp duty (but in this scenario the capital gains tax consequence is minimal), and our analysis suggests the payback period is under two years. We have not finalised that analysis and recommendation for this client, but it demonstrates just how valuable negative gearing can be, particularly in a higher interest rate environment like the one we are in now.
When it comes to shares, the question of whether to establish a family trust is one we often deliberate over carefully. Reflecting on 20 years of experience, I have regretted not establishing a family trust to hold a share portfolio far more often than I have regretted establishing one. In fact, I cannot recall a single instance where I wished we had not set one up, but there have been several where I wished we had.
Simplicity has its merits, and unnecessary cost and complexity should be avoided. But pursuing simplicity at the expense of (taxation) flexibility can be a costly mistake. Because a share portfolio can be divested selectively, selling certain holdings in certain tax years to manage liabilities, holding it in a family trust provides meaningful additional flexibility, including the ability to distribute gains to different beneficiaries across different years. For that reason, we tend to favour holding share portfolios in family trusts.
When it comes to tax planning, the ownership structure is an important upfront and ongoing consideration.
Funding structure: the lever most investors underuse
Gearing, that is, borrowing to invest, can be one of the most significant contributors to investment returns. As I have noted previously, gearing is responsible for close to half the total return in a typical property investment. This shapes how we think about the property versus shares decision. We do not see it primarily as an asset class choice. We see it as a gearing decision. If introducing debt into your investment strategy is appropriate and beneficial for your circumstances, property is generally the better asset class to use. If gearing is not appropriate, shares are likely the better path.
A common mistake is misusing gearing. Some investors borrow too heavily, and the consequences can be severe. Gearing is a great servant but a terrible master. The tax benefits of borrowing also diminish sharply once taxable income falls below $45,000 per year. Over the years I have seen investors gear so aggressively that they have little or no taxable income, which means the tax benefit on a portion of their borrowings is effectively nil. That defeats the purpose and adds risk without commensurate reward.
I have also seen investors go too far in the other direction. We recently spoke with an investor who had repaid all debt across a substantial investment portfolio. We would not have taken that approach. There is a meaningful difference between conservative gearing and zero gearing, and we think that for most investors maintaining a modest level of debt is financially more efficient than holding none.
It is also important not to conflate two distinct decisions: how to fund an investment, and the investment itself. These should be thought through separately. Getting the gearing decision right, including whether to gear at all, how much to borrow, and through which structure, can be far more consequential to your long-term outcome than optimising for a marginal tax saving.
The variable that matters most, and where to direct your energy
Beyond ownership structure and gearing, the single most important driver of long-term after-tax returns is the performance of the underlying investments. This is where I think investors should direct most of their focus, energy, and attention.
As I discussed in last week’s blog, I no longer view property as a set-and-forget investment. Policy risk has increased, and property investors need to be more proactive as a result. The goal is to increase the probability of capturing as much income and capital growth as possible, to offset the drag created by higher policy risk and a rising tax burden.
The same is true for shares and superannuation, depending on the size of the portfolio. A few weeks ago, I wrote about how to construct an ETF portfolio in a way that reduces risk while improving the probability of above-average returns over the medium and long term. Investors who do not have the experience or skill to do this themselves should consider seeking advice from someone who does. How and where you invest are among the most important decisions you will make, because the quality of those decisions will largely determine your long-term outcomes.
The broader point is this: focus on what you can control. You can control how proactively you manage your investments, whether you seek good advice, and whether your decisions are evidence-based and oriented towards the best long-term outcome. You can resist the temptation to react to short-term noise, and short-term thinking in general. What you cannot control is changes to tax law, tenancy legislation, and similar policy matters. That is not to say we should ignore them entirely. We should always ask whether there is something we can do to improve our position. But for most investors, the options are relatively limited – do those things and move on. Energy is probably better directed towards optimising the investments themselves.
Putting it all together: a hierarchy of what drives return
Investors are constantly bombarded with commentary about tax. Budget announcements, policy reviews and media coverage all create the impression that tax is the central variable in investment success. It rarely is.
If I were to rank the levers that determine long-term after-tax investment outcomes, it would look something like this:
- Asset selection and ongoing management. Choosing quality assets and managing them proactively is the dominant driver of returns. Nothing else comes close.
- Funding structure. Whether you gear, how much, and through which structure can account for close to half your total return on property and materially lifts returns across asset classes.
- Ownership structure. Getting this right from the outset, and revisiting it when circumstances change, can deliver meaningful tax efficiency over decades.
- Tax planning within your structure. Timing of disposals, distribution strategies, use of losses and similar levers all add value, but they operate within the constraints set by the decisions above.
The important observation is that by the time you reach item four, much of the outcome is already determined. Tax planning on a poorly selected, ungeared asset held in a suboptimal structure is optimising the least important variable last.
The arithmetic is hard to ignore. An investor earning 8% per annum who pays a higher rate of tax will still significantly outperform one earning 5% who pays less. Over 30 years, a $1 million portfolio growing at 8% per annum becomes roughly $10.1 million before tax. The same portfolio growing at 5% reaches $4.3 million. No tax saving closes that gap.
This is not an argument for ignoring tax. It is an argument for proportion. Whatever CGT changes are announced, we will do everything we reasonably can to help clients navigate them. But the investors who fare best over the next decade will not be those who find the cleverest tax structure. They will be those who make better investment decisions, maintain sensible gearing, avoid costly mistakes and stay focused on long-run performance. Higher tax on strong returns still beats lower tax on weak ones.
The goal has not changed: build a portfolio of quality assets, funded intelligently, held in the right structure, and proactively managed. Tax is one input into that system. An important one, but not the one that should be driving the conversation.
