What’s so bad about Negative Gearing?


If you’ve missed the recent political and media beat-up surrounding the negative gearing debate, it’s likely you’ve been hiding under a rock. Suddenly, it seems, negative gearing is a terrible thing that favours the rich and creates inequality for the average tax payer. It’s been blamed for various ills including high property prices, keeping first-time home buyers out of the property market, tax rorts and causing budget deficits.

All this is far from true and when you understand and analyse the issues, you’ll see that the hype is largely driven by those who just don’t understand the deeper issues.

Read on and I’ll explain why property investing is a real and effective method for bolstering the savings of middle-class Australians that, at the same time, provides accommodation for those whom the government can’t, or won’t.

My view is that negative gearing should remain as it is, so let’s demystify Negative Gearing and take a look at what’s really going on.

What is Negative Gearing?

Basically, it’s a tax arrangement that allows you to offset losses incurred through investment property ownership against the totality of your taxable income. Here’s an example:

Say you own an investment property that generates $15 000pa rent to you, the landlord. But, as landlord, the costs of owning that property are $20 000pa (costs include such expenses as insurance, maintenance, taxes and interest payments to the bank, amongst others). In effect, you’ve made a loss of $5 000pa. Negative Gearing is a tax arrangement that allows you to offset that $5 000 loss against any other income you receive. So if your annual salary is $80 000pa, you can claim a $5 000 deduction against this $80 000, and only pay tax on $75 000 (ignoring any other tax deductions applicable).

This tax-offset arrangement is available until the property become positively geared (the income it generates is greater than the cost of owning the investment property). At the point the property becomes positively geared, you’ll pay tax on the income it generates.

So why all the political and media beat-up about negative gearing being a bad thing?

It’s apparently unfair. There’s a few arguments circulating to this effect, including:

  • offsetting the loss against tax means less fortunate tax payers are helping to pay for the “wealthier half” to own an investment property
  • it unfairly favours the rich because billionaires can negatively gear the same way as average earners
  • it pushes up house prices because investors are buying-up housing stock for the tax benefits
  • the government loses out on tax revenue it would have received had the investor paid tax on all income.

Let’s take a closer look at these arguments.

  • Negative gearing is not an investment strategy, per se. Why would any sane person enter a business deal to lose money? The answer is because you hope that, over time, your losses will be made up by the capital growth in the value of the asset. This capital growth can then be used to refinance, or to realise a capital gain when the asset is sold. Negative gearing only makes sense from an investment point of view if the property value increases over time.
  • The same rules apply to the rich as to the less wealthy, however, two-thirds of Australia’s two million property owners negatively gear. Of these, 70% earn less than $80k per year. The tax benefits of negative gearing have allowed many ordinary, working class Australians, to invest in property and take control of their financial future. Given our ageing population and government’s propensity toward self-funded retirements, this can only be a good thing long-term, right?
  • It’s a smokescreen to say negative gearing pushes up housing prices. In OS countries where negative gearing is not allowed, they’ve experienced a boom, and much greater subsequent bust, than that which Australia has gone through. To me, it seems lobbyists don’t recognise that borrowing money to undertake productive investment, helps economic growth.
  • And does the government lose out? Not really. A property may start out with a large loan and low rent. Over time, the loan decreases and the rent increases and the Tax Office gets its share. Additionally, every dollar claimed as a deduction has a corresponding dollar of income assessable to the lender.

 

In my next post, I’ll examine the arguments for leaving negative gearing arrangements as they are. I hope you’ll join me then as I outline the ramifications of changing the status quo.

 

Written by:

George Markoski Positive Property Solutions Adelaide