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Published on April 24th, 2017

Negative gearing – what you need to know

With the next Federal Budget due within the next month, housing affordability is once again a hot topic. There are a number of policy positions that could be on the table, but no affordability debate is complete without negative gearing rearing its head.

If you’re a real estate investor, or considering taking the plunge, it’s worth a look at the debate as a whole.

How negative gearing works

‘Gearing’ means borrowing funds in order to finance an investment. If the cost of servicing those loans outweighs the income earned on the investment, it is a negatively geared investment. The borrower may then claim those losses as a tax deduction.

Although claiming losses as a deduction is a fairly standard feature of taxation systems, the Australian system differs from the norm in that the losses are not quarantined against the rental property.

Prior to 1985, investors could carry forward losses to offset income at a future time when the property becomes positively geared. After the Hawke reforms, those losses could be applied against your overall income. This means that a rental property which makes a loss becomes an attractive proposition for high income earners who wish to reduce their overall tax liability. These investors aren’t buying rental property for the income, but for the capital growth when it comes time to sell.

Arguments for

The policy motivation for negative gearing was, and is, to increase housing supply and encourage supply of private rental housing at a reasonable rent. Industry groups including the Housing Industry Association argue that removing negative gearing would discourage investment, meaning a lower supply of rental properties which would in turn make it harder for renters to find a home. In addition, landlords who no longer had an incentive to keep their rental income low would raise rents, squeezing the most disadvantaged sectors of society further.

With around two thirds of real estate investors having a taxable income of $80,000 or less, it’s seen as a way for ‘mum and dad’ investors to build financial security and provide themselves with an income stream at retirement. Like many countries, Australia’s population is ageing, making retirement income an important policy issue.

It’s also worth noting that the ATO will look closely at investors who charge significantly less than market rent for their properties in order to inflate their deductions, which limits how much the property can offset other income. Held for long enough, all rental properties become positively geared as rents rise and mortgage repayments decrease, offsetting early losses into future tax windfalls for the government.

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Arguments against

Groups arguing for negative gearing reform argue that negative gearing encourages wealthy investors to purchase existing housing stock, increasingly housing affordability. The Australian Bureau of Statistics indicates that 93% of new investment loans go to people purchasing existing housing stock rather than new homes. As investors are able to purchase second and third properties using their own home as collateral, they don’t face the barrier of coming up with a deposit – that means that new home buyers are at a disadvantage.

The Australian Council of Social Service (ACOSS) claims that the majority of negative gearing deductions are claimed by investors in the top 10% of income earners. They point out that a taxable income of $80,000 is calculated after negative gearing and other deductions have been applied, and do not present an accurate picture of the gross income earned by investors.

In 2016, negative gearing deductions had an impact on the Federal budget of around $2 billion.

Where do the major parties stand?

If you’re considering buying an investment property, you may be relieved to hear that neither of the major parties is promoting a complete repeal of negative gearing benefits. Labor proposes to limit negative gearing to new housing only, with all existing investments unaffected and fully grandfathered. The Liberal Party is steadfast in its position that there will be no changes to negative gearing.

Even the Greens, who support the complete removal of negative gearing for property purchases, guarantee that assets bought before the relevant date will be grandfathered.

With the next election years away yet, then, you can go forth and bid on that inner city unit in safety!

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