The Albanese government has released draft legislation to fix the so-called “widow tax” loophole, ensuring Australians who inherit an investment property from a spouse do not lose existing negative gearing benefits.

The issue arose from Labor’s budget reforms, which restrict negative gearing to newly built homes purchased after May 12 while grandfathering existing investment properties. Under the original legislation, a surviving spouse inheriting a share of a jointly owned investment property could have been treated as acquiring it after the cut-off date, potentially losing access to negative gearing.

The proposed changes would allow the tax treatment to continue when ownership is transferred through inheritance or as part of a divorce or separation settlement.

ACT Senator David Pocock, who publicly raised concerns about the loophole, welcomed the draft legislation, saying it appeared to address “many of the most urgent concerns” with the reforms. He said it was important the legislation was passed quickly so lenders could consider preserved tax benefits when assessing borrowers.

The exposure draft, open for consultation until August 21, also includes measures designed to support investment in new and affordable housing.

Under the changes, a newly built home would continue to qualify as “new” for up to 24 months after its occupancy certificate is issued, allowing developers more time to sell properties without the next buyer immediately losing negative gearing eligibility.

Labor is also proposing exemptions for established properties used as NDIS specialist disability accommodation, affordable housing managed by community housing providers, public housing and qualifying build-to-rent developments.

The draft legislation also outlines transitional arrangements for Labor’s new capital gains tax system, allowing owners of property and other difficult-to-value assets to use a formula rather than obtaining formal valuations when calculating gains under the new indexed model.

Acting Opposition Leader Jane Hume said Labor was “still trying to clean up a mess of its own making”, arguing the government had rushed through flawed legislation before consulting on changes.

Treasurer Jim Chalmers said the draft amendments would ensure the tax reforms appropriately addressed a range of taxpayer circumstances and formed part of the government’s broader tax reform package.