The Federal Government’s proposed capital gains tax (CGT) and negative gearing reforms are moving through the drafting process, with the Tranche 2 exposure drafts released in August 2026 providing more detail on how the new rules may operate.

Luke Henry and Eric Zheng prepared a submission to Treasury covering 14 issues across the four Tranche 2 packages. Much of our feedback concerns clarification and workability, but three issues could have significant financial consequences under the current drafting. A fourth raises a broader concern about an integrity rule affecting new residential dwellings.

The Federal Government’s proposed capital gains tax (CGT) and negative gearing reforms are moving through the drafting process, with the Tranche 2 exposure drafts released in August 2026 providing more detail on how the new rules may operate.

LDB has lodged a submission to Treasury covering 14 issues across the four Tranche 2 packages. Much of our feedback concerns clarification and workability, but three issues could have significant financial consequences under the current drafting. A fourth raises a broader concern about an integrity rule affecting new residential dwellings.

Here are the key issues for property investors, private groups and families planning for succession.

If you own an investment property that has been substantially improved

One of the proposed CGT measures provides a formula for dividing a capital gain between the periods before and after 30 June 2027. The split matters because the two periods are taxed very differently. Gains attributed to the earlier period keep the 50% CGT discount and sit outside the new 30% minimum tax. Gains attributed to the later period get indexation instead, with no discount, and the minimum tax applies.

LDB identified an inconsistency in the formula. One step estimates the property’s growth using only the original purchase price, while a later step compares that estimate against the full cost base, including stamp duty and the cost of any improvements. Money spent improving the property reduces the calculated gain without being treated as having added anything to the property’s value.

The consequence is not that the gain disappears. It is that a large part of it is pushed out of the concessionally taxed period and into the fully taxed one.

Take land bought for $300,000 with $15,000 of acquisition costs, a $700,000 dwelling built on it before 1 July 2027, and the property eventually sold for $2 million. The economic gain is $985,000 either way. Only the split changes.

In LDB’s example, the difference is substantial:

*Figures assume an indexation factor of 1.24 for the post-30 June 2027 period and a 47% marginal rate

Roughly $186,000 of additional tax on the same underlying gain, because the formula attributes $588,000 less to the period that carries the discount.

There is a second effect in the same direction. The formula’s implied 30 June 2027 value also becomes the cost base for the later period, so understating it reduces the indexation relief available as well. The taxpayer is worse off on both counts.

LDB has recommended that Treasury amend the formula, so the basis used to calculate growth is consistent with the cost base against which the result is compared.

If your private group uses a discretionary trust with a corporate beneficiary

The Tranche 2 rules deal with CGT indexation where a capital gain flows through a trust to a corporate beneficiary. Indexation is not available to companies, so the draft lets a trustee elect not to apply it. The trust then calculates the full nominal gain and applies its capital losses against that larger amount.

The difficulty is that eligibility for the election is tested immediately before the CGT event. A discretionary trustee will often not have determined at that point which beneficiary will receive the gain, so the election may be unavailable to precisely the trusts it was designed for.

Where it is unavailable, the trustee must calculate the smaller indexed gain and can only apply losses against that. The gain is then recalculated without indexation when it reaches the corporate beneficiary but the amount of losses already applied is frozen. The difference becomes assessable to the company, while an equivalent unused loss stays behind in the trust.

The trust had enough losses to eliminate the whole gain, but only $880,000 of them could be applied. The remaining $120,000 becomes assessable to the company while an equivalent $120,000 of losses sits unused in the trust, recoverable only against a future capital gain of that same trust (which may never arise where the trust held a single long-term asset).

Two otherwise identical trusts reach different outcomes depending only on whether the election happened to be available. The loss is not forfeited, but it can only be used against future capital gains of the same trust (which may never arise if the trust held a single long-term asset that has now been sold).

LDB has recommended testing eligibility by reference to the beneficiaries actually entitled to the gain at the end of the income year, when they are known. If the existing timing test remains, we have recommended allowing otherwise available trust losses to offset the increase that arises solely because indexation is later removed.

If your succession plan includes residential investment property

The proposed negative gearing rules preserve the existing treatment of grandfathered residential investment property when ownership changes in some circumstances.

A surviving spouse can inherit the deceased owner’s treatment. Continuity can also apply where an existing co-owner inherits the deceased owner’s remaining interest.

An adult child who inherits a property they did not previously co-own is treated differently.

LDB modelled a parent who acquired a rental property in 2012, held it until death in 2029 and left it to an adult child. The property generates approximately $28,000 a year in rental losses.

The difference is approximately $13,000 a year, even though the economic substance of the succession is essentially the same.

The drafting also creates an apparent incentive to establish nominal co-ownership before death simply to access the continuity rule, which is unlikely to be the intended policy outcome.

LDB has recommended extending continuity to individual beneficiaries who inherit residential property from a deceased estate, subject to appropriate integrity measures.

A fourth concern: when an incentive can undermine itself

LDB has also raised concerns about an integrity rule governing what qualifies as a new residential dwelling.

New residential dwelling status is important because it can provide access to more favourable treatment under the proposed negative gearing and CGT rules. The policy is deliberately designed to encourage investment in genuine additions to Australia’s housing supply.

The draft integrity provision, however, can apply where obtaining that treatment was “a purpose” of any entity involved in the arrangement.

That creates a potential contradiction.

A developer or investor assessing whether a new housing project is commercially viable might reasonably take the available tax treatment into account. On a literal reading of the draft, doing so may give them exactly the purpose that can cause the treatment to be denied.

The provision can also take account of the purpose of another entity involved in the arrangement, such as a developer, even where the eventual investor may have had no knowledge of that purpose.

LDB supports integrity measures aimed at artificial or contrived arrangements. Our submission recommends that the legislation be confined to arrangements that do not genuinely add to housing supply, consistent with the stated policy objective, rather than potentially capturing ordinary investment decisions the policy is intended to encourage.

Where things stand

The Tranche 2 measures remain in exposure draft form and may change before the legislation is finalised. Further detail on companies, general law partnerships and commercial restructures is also still to come.

With the reforms proposed to commence from 1 July 2027, the final drafting will be particularly relevant for people holding improved assets, private groups using discretionary trusts, families planning the succession of residential investment property and investors in new housing.

The implications will depend on the assets, ownership structures and circumstances involved. As the legislation develops, understanding how the final rules interact with existing arrangements can help inform future tax, property and succession planning.

LDB’s tax team continues to monitor the proposed CGT and negative gearing reforms and their practical implications.