The 2026-27 Federal Budget delivered a tax reform trio that is reshaping the investment landscape: changes to negative gearing, a return to CGT indexation (see CGT amendments: A blast from the past and a new minimum tax), and a minimum tax on discretionary trust distributions (see Discretionary Trusts - Limited time offer for relief from minimum tax). This alert unpacks the negative gearing reforms, which have now become law.
The Treasury Laws Amendment (Tax Reform No. 1) Act 2026 (the Act), which received royal assent on 26 June 2026, amends the Income Tax Assessment Act 1997 (the 1997 Act) to limit negative gearing for residential property investments to new builds from 1 July 2027 (subject to some transitional rules).
The changes represent a significant realignment of the negative gearing regime. With the new rules applying from the 2027–28 income tax year, this alert outlines the key features of the reforms and their potential implications for investors.
Background to the changes
Under the current negative gearing regime, net losses from assets such as rental properties can be deducted from other forms of taxable income (for example, salary and wages).
The changes form part of the Government’s broader housing agenda, which aims to improve tax system fairness and address housing affordability pressures for first homebuyers. The Explanatory Memorandum notes that the interaction between the 50% CGT discount and negative gearing creates strong incentives for investors to take on highly leveraged housing investments, contributing to higher house prices as investors compete for a scarce resource (Explanatory Memorandum, Treasury Laws Amendment (Tax Reform No. 1) Bill 2026, at paragraph 1.13).
Summary of the new rules
The changes apply to individuals, trusts, companies and partnerships holding residential property investments (other than exempted entities). In short, the changes mean:
- Excess deductions from holding or owning residential properties acquired after 7:30pm (AEST) on 12 May 2026 cannot be deducted against other forms of income (e.g., salary); and
- Those deductions can instead be carried forward and deducted against income from the residential property in future years or deducted against the income of other properties.
- Transitional rules will apply to allow:
- Properties held at announcement (before 7:30 pm AEST on 12 May 2026) to continue to be negatively geared until they are sold; and
- Properties purchased after Budget night but before 30 June 2027 may be negatively geared during that interim period, but not in subsequent income years.
Certain residential dwellings will be exempt, including:
- New builds; and
- Certain housing supporting government housing priorities, such as build-to-rent developments and dwellings provided as social or affordable.
Specified entities will also be exempted, including:
- “Widely held unit trusts” within the meaning of section 272-105 in Schedule 2F to the Income Tax Assessment Act 1936 (the 1936 Act); and
- “Complying superannuation entities”; and
- Employers incurring expenditures to provide housing fringe benefits.
The changes in detail
Schedule 2 of the Act implements the changes through a new section 26-155 in the 1997 Act. The quarantining rules apply to any entity (individual, trust or company) that uses or holds a “residential dwelling” as residential accommodation, unless the entity is an exempted entity under subsection 26-155(4). Excess deductions over assessable income from residential dwellings acquired on or after 7:30pm (AEST) on 12 May 2026 will be “quarantined”.
Quarantined amounts can only be applied against net assessable income from residential dwellings used or held as residential accommodation (including capital gains from residential property). Any excess can be carried forward and offset in future income years or offset against income from other residential properties. This applies from the 2027–28 income year. The key point is: excess deductions cannot be deducted against other income such as salary.
The Act defines a “residential dwelling” in section 26-160 as a dwelling, other than: caravans, mobile tiny homes or mobile homes; hotels, motels, inns, hostels or boarding houses; student accommodation provided in connection with a school or educational institution; boats or other marine vessels; and other classes of dwellings determined by the Minister.
Exceptions for certain residential dwellings
Importantly, “new residential dwellings” will be exempted by section 26-155(2)(b), reflecting the policy of restricting negative gearing to new builds. Whether a dwelling qualifies will depend on ministerial determination, potentially including whether a new build replaces an existing dwelling or genuinely adds to housing supply. The Budget factsheet indicates that knock-down rebuilds or substantial renovations that do not increase supply will not be eligible, and that a new build cannot have been previously sold unless first owned by the builder and not occupied for more than 12 months.
On 4 August 2026, Treasury released exposure draft legislation for the Treasury Laws Amendment (Tax Reform No. 3) Bill 2026 (Tranche 2) for consultation. The draft proposes that a property will generally be considered “new” where it genuinely adds to housing supply, provided it was acquired within 24 months of a certificate of occupancy being issued — extending the 12-month period originally set out in the Budget to give builders and developers time to sell stock on hand. Consultation closed on 21 August 2026.
Properties acquired before 7:30pm (AEST) on 12 May 2026 are grandfathered. Section 26-155(2)(a) provides that the quarantining requirements do not apply to an ownership interest in a residential dwelling acquired before this time. This protects investors who made decisions under the settings in place prior to Budget night. Notably, for residential dwellings acquired under a contract, subsection 26-155(3) provides that the taxpayer is taken to have an ownership interest from the time the contract is entered into — not at settlement.
The Treasury Laws Amendment (Tax Reform No. 2) Act 2026, which received royal assent on 26 August 2026, extends these grandfathering exceptions in certain circumstances. Sections 26-156 to 26-158 preserve existing eligibility for negative gearing where a residential dwelling is acquired from a spouse (or former spouse) as a result of relationship breakdown, or where a co-owner (whether a spouse or not) inherits a deceased co-owner’s interest. This ensures that a transferee who acquires a pre-Budget dwelling or a new residential dwelling in these circumstances is not disadvantaged by the quarantining rules.
The Act also provides for additional exemptions to be created for residential dwellings connected to activities or purposes as to be determined by the Minister by legislative instrument, where the Minister is satisfied that the determination assists social or affordable housing or housing outcomes for disadvantaged groups.
Exceptions for specified entities
Subsection 26-155(4) exempts certain entities from the quarantining requirements. These include widely held unit trusts (as defined in section 272-105 of Schedule 2F to the 1936 Act) and complying superannuation entities. The Explanatory Memorandum confirms that superannuation funds, including Self-Managed Super Funds (SMSFs), are excluded from the changes in recognition of their distinct regulatory and investment frameworks. However, Schedule 5 of the same Act prohibits SMSFs from using limited recourse borrowing arrangements (LRBAs) to acquire residential property, which may significantly affect the practical utility of this exemption for SMSFs seeking to finance residential property acquisitions.
Additionally, subsection 26-155(5) provides that the quarantining rules do not apply to expenditure an employer incurs in providing a fringe benefit to an employee, such as a housing fringe benefit. This ensures businesses that directly provide residential accommodation to their employees are not affected by the negative gearing restrictions. The exception is consistent with the general treatment of fringe benefit expenses under the income tax law and mirrors similar carve-outs in other loss quarantining provisions.
Further provisions for trust beneficiaries, bankrupt entities and capital gains
The Act also contains further modifications to the general quarantining rule, including:
- Trust beneficiaries and interposed entities: subsection 26-155(7) modifies the quarantining rule where amounts are included in a beneficiary’s assessable income under Division 6 of Part III of the 1936 Act. To the extent such income is referable directly or indirectly through partnerships or trusts to holding residential dwellings as residential accommodation, it will be quarantined. This ensures quarantining applies through interposed structures while preserving Division 6 trust taxation principles.
- Extensions for inheritance and relationship breakdown: the Treasury Laws Amendment (Tax Reform No. 2) Act 2026 inserted new sections 26-156 to 26-158, extending the grandfathering exceptions discussed above to certain transfers on relationship breakdown or inheritance. The Tax Reform No. 2 Act also provides exemptions from the minimum tax on capital gains for genuine testamentary trusts, deceased estates and special disability trusts (see our related alert: Discretionary Trusts - Limited time offer for relief from minimum tax).
- Bankruptcy: subsections 26-155(8)–(9) address bankruptcy scenarios. Where an entity is declared bankrupt, released from a debt under bankruptcy law, or where an existing bankruptcy is annulled under a composition or scheme of arrangement (s 74 of the Bankruptcy Act 1966 (Cth)), current-year quarantined amounts not yet applied under section 102-5 are denied for the current or later year. This prevents accumulated quarantined losses from being utilised by the entity (or the bankrupt estate) against future residential property income or capital gains after the bankruptcy event.
- Interaction with capital gains: quarantined amounts can be applied against net rental income from residential dwellings and against revenue gains and capital gains from CGT events happening to such dwellings. However, subsection 26-155(6) requires a preliminary adjustment: before the quarantining mechanism takes effect, the excess deductions are first reduced by any net gains from non-quarantined residential dwellings and by any revenue gains from residential dwellings that are revenue assets. Such gains effectively absorb some or all of the excess before it becomes a quarantined amount.
Remaining questions
Substantial aspects of the regime are left to be determined, including:
- Classification of “new residential dwellings”: although the Tranche 2 exposure draft proposes a 24-month acquisition window from certificate of occupancy, this definition remains subject to finalisation following consultation. Whether there might be further exemptions for particular activities or purposes as enabled by sections 26-155(2)(c) and (d) also remains to be determined. The consultation also proposes specific exemptions for NDIS housing, public housing, and build-to-rent developments.
- Main residence first-use exemption: the consultation also proposes preserving existing negative gearing and CGT treatment when a taxpayer first uses an eligible main residence to produce assessable income. This may offer an independent basis for relief beyond the grandfathering provisions discussed above.
- Mixed-use properties: the treatment of mixed-use properties presents another area of uncertainty. The Act focuses on dwellings used or held as residential accommodation, but currently does not provide clear guidance on properties that serve both residential and commercial purposes, or properties that transition between uses during an income year. The Tranche 2 consultation materials include a draft legislative instrument specifying the method for apportioning capital gains and losses for real property and assets without a readily ascertainable market value, which may provide guidance on this issue. It remains to be seen whether similar apportionment rules will apply for negative gearing purposes.
- Anti-avoidance provisions: the Tranche 2 exposure draft includes anti-avoidance provisions. Industry commentary has noted that these rules are broad and self-executing — they apply where obtaining a tax benefit is merely one purpose (not necessarily the dominant purpose) and automatically remove access to the concession. The scope and operation of these provisions will require careful consideration once the final legislation is enacted.
- Trust and partnership look-through provisions: the look-through provisions for trusts and partnerships in subsection 26-155(7) raise interpretive questions regarding the practical application where multiple trusts or partnerships are interposed, or where discretionary trust resolutions vary from year to year.
- Membership interests in property-holding entities: a capital gain on the sale of membership interests in a trust or company holding a residential dwelling would be classified as a non-residential capital gain under the new CGT categories. Any quarantined amounts carried forward could not be applied against the gain.
Next steps for investors
Although the Treasury Laws Amendment (Tax Reform No. 1) Act 2026 has passed, the Government is implementing the reforms in stages. The Treasury Laws Amendment (Tax Reform No. 2) Act 2026 received royal assent on 26 August 2026, addressing further negative gearing amendments in Schedule 4. Treasury released exposure drafts for Tranche 2 (the Treasury Laws Amendment (Tax Reform No. 3) Bill 2026) on 4 August 2026, with consultation having closed on 21 August 2026. Further tranches are expected to address interactions with CGT rollovers and similar concessions, application of the CGT reforms to foreign, mixed and temporary residents, and tax consolidated groups.
As at the date of this alert, the ATO has not issued detailed administrative guidance (such as a ruling or practical compliance guideline) on the operation of section 26-155 - such guidance is anticipated but not yet available.
What this means for investors:
- Record-keeping for grandfathered properties: establishing that a property is grandfathered and exempt from quarantining will require documentation evidencing the acquisition date, including signed contracts and contemporaneous correspondence;
- Investment modelling: properties acquired after the announcement time that do not qualify as “new builds” will only permit losses to be offset against other residential property income or capital gains, with any excess carried forward. This affects the after-tax returns from future residential property acquisitions;
- New residential dwellings: the “new residential dwellings” exemption discussed above provides a pathway for negative gearing to continue. The definition of this exemption remains subject to finalisation following consultation;
- Portfolio restructuring: investors with a mix of grandfathered and newly acquired properties will need to segregate their income and deductions accordingly. Quarantined amounts are tracked separately for each affected dwelling and carried forward until they can be applied against qualifying income or gains;
- Trust and partnership structures: the look-through provisions discussed above apply to investors holding residential property through trust or partnership structures. The practical application of these provisions may be affected where multiple entities are interposed, or discretionary trust resolutions vary year to year;
- Exit timing: where an investor has accumulated quarantined losses, a direct asset sale (rather than a sale of membership interests in an entity holding the property) may allow quarantined amounts to be utilised; and
- Further developments: the reforms are being implemented in stages, and it is expected that future tranches of legislation will address additional aspects of the regime.
For further information on the negative gearing changes and their impact on your specific circumstances, please contact a member of the Mallesons Tax team.
