What needs to change about negative gearing | Pete Wargent

So-termed “negative gearing” is brought up for debate at least once a year, and now appears to be that time.strategy-design

To clarify, negative gearing is not a special ruling per se, rather it is a fundamental principle of Australian tax law that expenses may be deducted from income and, as such, has “been around” for decades.

Over the years I’ve come to realise that while everyone has an opinion on negative gearing , usually (though not always) based upon whether they are a property owner or not, very few people understand how it works in practice.

That’s hardly surprising, since it’s rarely well explained in the media. Take this from ABC :

“Under Australian tax law, negative gearing is available to anyone who owns an investment property. If the money you make from rent doesn’t cover your mortgage repayments, you’re allowed to deduct the difference—the loss you’ve made—from your annual income tax.” 

There are so many inaccuracies in these two sentences it’s hard to know where to begin.

negative gearing is available to anyone who owns an investment property” – clearly not, but perhaps just carelessly worded, in fairness.

 If the money you make from rent doesn’t cover your mortgage repayments, you’re allowed to deduct the difference”

Gosh, no! Definitely not the case.

This is a mangled understanding of tax legislation…engage an accountant if you aren’t sure!

Interest payments may be deductible as well as certain other directly attributable operating costs, including depreciation and some other borrowing costs.

Whatever happens don’t try to claim any capital repayments as recommended here, since you’ll get into froth & bubble with Australia’s taxation office.

you’re allowed to deduct the difference—the loss you’ve made—from your annual income tax

Ah, if only ’twere true!

Again definitely not – losses calculated as explained above after depreciation (what the Americans tend to term “paper losses”) are offset against income, and certainly not against your annual tax, although that would indeed be nice.

I wrote a short article on how negative gearing works in practice using actual a few examples here.

Negative Gearing – What Needs to Change?

When dwelling prices are in their up-cycle tax law tends to be cited as problematic, with a specific criticism being that so-termed “negative gearing” fails to increase the supply of housing stock in the market.

Yet the aggregate of market demand for property clearly is increasing supply, with rolling annual building approvals breaching record highs in August.

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Over the next two years a stream of stock is due to come online, with real rental growth already set to decline (Perth, Canberra and Darwin look set to win the race to below zero), and requirements for macro-prudential measures or the quarantining of negative gearing rules will fade in concert with easing dwelling price growth.

NG2

There’s little doubt that tweaking existing tax laws would choke investor demand and market prices would ease.

However, as in the parable The King, the Mice & the Cheese, targeting one distortion in a market merely ignites others – in this case building approvals would evaporate as prices decline, and the ‘sticker shock’ would put the kybosh on any economic recovery as consumer spending is stymied and dwelling construction dissipates.

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Given the above I’d be very surprised if tax legislation was amended, although perhaps if interest rates headed significantly closer to the zero bound the case for restricting deductions prospectively to new dwellings only might gather a head of steam.

Whilst impossible to model accurately, if the failed 1985-7 experiment is a useful benchmark increases in tax receipts would be offset by escalating public housing costs, and I believe that within the course of one solitary property cycle we’d be having the same old discussions about capital city housing affordability due to supply failure.

Housing is obviously not unaffordable across all of Australia.

The problem such as it exists is that so few attractive or viable alternatives are presented to those wanting to opt out of the capital city lifestyle.

To perm New South Wales as an example, the state population has increased by close to a nontrivial 400,000 over the past four years alone, yet outside Greater Sydney the remainder of the state has created employment growth equalling a grand total of…negative 16,000 jobs.

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NSW population growth is now accelerating as the tide of interstate migration now shifts away from the mining states, yet it’s plainly unrealistic to expect folk to flock to the regions without adequate business investment or infrastructure, since there are actually fewer regional jobs in the state today than there were back in 2010.
Scrapping tax deductions provides a band aid remedy only.

Clinging to the notion that we can house 8 or 9 million people affordably within a contained centric space is folly, and ultimately doomed to failure.

NSW does not stand for “Newcastle, Sydney, Wollongong”, but until we collectively accept that, expect more of the same.



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Pete Wargent

About

Pete Wargent is a Chartered Accountant, Chartered Secretary and has a Financial Planning Diploma. He’s achieved financial freedom at the age of 33 - as detailed in his book ‘Get a Financial Grip – A Simple Plan for Financial Freedom’. Pete now manages his investment portfolio, travels and works as a consultant in the finance industry from time to time. Visit his blog


'What needs to change about negative gearing | Pete Wargent' have 1 comment

  1. December 6, 2014 @ 10:27 am Matt Heidari

    Negative gearing when started aimed to make rental housing available for people who were not able to buy their own homes. Today negative gearing is much far away its first aims and now it prevent of young people to be able to buy their own home and force them to rent. Negative gearing makes the price of established houses increase and make them unaffordable for young people who have not big savings or big income. Governments by negative gearing give big subsidy to high earners to buy house and rent it out to low earners. The question is why governments do not give this subsidy to low earners to help them to buy and keep their own homes. At first negative gearing was a medicine for patient to relief some of his pains but no one thought about the side effects of this medicine and no one thought when to stop this medicine. Gradually patient addicted to this medicine and no one can stop it. Negative gearing cannot live in forever. It is a wrong economy model and if no one do anything about it, it will collapse and will destroy economy with itself. The only option is governments start to phase out negative gearing gradually. For example starting to remove negative gearing for houses with 30 years age and after 5 years 15 years old houses and so on. This should be done similar to the process for rehabilitating addicted people. There are millions of Australians who live on negative gearing either land lords or property agents, accountants, banks and etc. If no one do anything for negative gearing, the market forces will abolish it sooner or later but with uncontrolled side effects.
    Matt.H

    Reply


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