Why negative gearing should not be abolished for property investment

Once again the value of negative gear to allow  investors to buy their investment properties has come into question.

Some academic commentators and social welfare lobbyists seem to regard negative gearing as primarily a tax avoidance device used by the wealthy to rort the system, which has the added consequence of pushing up property values.

Negative gearing is not just for the rich

The assertion that all negatively geared property investors are ‘ugly wealthy Australians’ is simply unfounded and incorrect.

According to 2006/07 A.T.O taxation records 1.6 million taxpayers claimed rental income, and of those, two in three negatively geared their investment/s. Interestingly, these investors predominately do not come from the wealthy end of town. Indeed, 74 per cent of negatively geared investors earned less than $80,000. Only 4 per cent were in the top tax bracket.

Fact is using the benefit of negative gearing investment has allowed many ordinary working class Australians to invest in property and to take control of their financial destiny.

Property investors provide an essential service

While some opponents of negative gearing appeal to the frustration of would-be home owners, suggesting they have been locked out of the market by greedy, tax-driven property investors who receive billions of dollars of tax breaks which pushes up property prices, I would argue that property investors provide an essential service to millions of Australians who chose to, or have to, rent their accommodation and as such these investors should be treated like all other business people.

In our modern society we pay taxes and expect the government to provide us with certain essential services. These include hospitals, roads, schools, jails, public transport, aged care and public housing.

In Australia the government often shares the burden of providing these services with private enterprises that can often deliver them more efficiently and cheaper.

When the government can’t supply enough public hospital beds, private run hospitals step up to the mark and not only receive tax deductions for their business loans, but also allowances to subsidize them. So do aged care providers, schools and public transport providers who provide services in tandem with the government.

Our government also provides public housing, but not enough for all those who can’t afford to buy their own property. While government programs, such as the National Rental Affordability Scheme and other social and public housing programs are helpful, it is only the private rental market that can deliver rental accommodation at the rate and scale that is required at present.

Property investors save a deposit, buy a property, commit to a loan for 25 or 30 years and provide accommodation for others in our community. In return we expect to get a reasonable return on our investment risk, just like other business people do.

We know that the rent won’t cover our expenses, but accept that certain tax benefits plus the long term capital growth will make up for this.

Sometimes it does, and sometimes it doesn’t.

What if the government removes negative gearing?

Leverage and negative gearing compounds returns in the good times, but multiplies losses when property prices are flat or falling. I know as many people who have lost money in property investment as those who have made money.

Much like most other small business people.

If the government takes away my tax concessions, I would have to consider my investment options. To ensure I get a decent return I’d put up my rents if I could, or maybe I’d invest elsewhere to get the best bang for my bucks.

The result would be that rents would rise and tenants would have to fight over the few rental properties left, or the government would have to invest it’s own money and buy or build properties and enjoy the pleasures of being a landlord.

Of course the government already provides some public housing, but not enough, leaving the task of providing rental accommodation not only in our capital cities, but also in regional Australia and in the remote mining towns to private investors. People like you and me who have chosen to run our own little property investment businesses.

If I set up a dog wash business or a restaurant, I’d be able to claim a tax deduction for legitimate business expenses including loans to set up our business or purchasing business equipment.

Why should it be different for property investors who take on a business risk?

Doesn’t negative gearing push up property values?

To say negative gearing has pushed up property prices is a smoke screen.

Just look what happened to property prices overseas in countries like the USA and parts of Europe where negative gearing isn’t allowed. They experienced a boom and a subsequent bust of much greater magnitude that we have.

What these lobbyists may not recognise is that borrowing in order to undertake productive investment actually helps economic growth because value is being added.

After all, there will always be some investments which have lower returns than the interest expenses on the loans taken on to acquire them. This economic reality has nothing whatsoever to do with tax.

For example a typical property investment may start off with a large loan and lowish rent. As time goes by the loan is paid down and the rent increases. Overall the investor makes a profit and the tax office gets its share of this.

Actually, there is not as much loss of revenue to the authorities as some critics believe because for every dollar of interest claimed as a tax deduction by a borrower there is a corresponding dollar of interest assessable to a lender.

But that’s not all…

If the governments stops the availability of negative gearing benefits the danger arises that there may be unintended consequences.

It is possible that even following a positive cash flow strategy you end up negatively geared and suffer. What if:

• Interest rates rise after you buy your investment?

• Rents fall or your property becomes vacant for a period of time? Or

• You have to undertake a major repair of your investment property.

To deny the person making commercial a loss like this a tax deduction would be to inflict a double whammy on them and increase their hardship unduly.

In conclusion:

Any reduction in negative gearing benefits would significantly reduce rental investment in both new and existing properties and would worsen rental affordability through a reduced supply of investment housing. A reduced rental supply means lower rental vacancies and increased rents.

Property investment is a real and effective method for bolstering the savings of middle Australia at the same time providing accommodation for those who the government can’t or won’t help and should remain as is.

[post_ender]

 



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'Why negative gearing should not be abolished for property investment' have 2 comments

  1. November 10, 2012 @ 1:56 pm Cam

    Mr Yardney,
    Re: The Tax Treatment of Negative Geared (loss in the Fin Yr) Property

    1. I think there is a tremendous misunderstanding in the community about negative gearing tax treatment because of the manner in which those that argue against it produce such an uninformed and biased case. I have read much material from these people and very little of it stands up to close scrutiny and analysis. There is frequently a very selective use of facts, many half truths and a great deal of misinformation on the subject. As will be shown below, it is quite illogical and misleading to refer to the tax treatment of a negatively geared (ie. a loss making property in the Fin. Yr.) as a “tax concession” because effectively it is not.

    From what I have read most of the anti -NG tax treatment proponents have had zero experience with owning an investment property and have no idea of the heavy expenses involved and the significant financial risks taken by owners when venturing into this type of investment.

    2.. The NG Tax Treatment opponents typically ignore a couple of basic facts about property investing.

    A. The property investor makes a whacking big loss as soon as he purchases the property and, in some (perhaps many) cases, that loss is often not fully recoverable until the property is sold at a sufficient profit. This loss is a large tax called “STAMP DUTY”. Given the high cost of property, stamp TAX is now a major start up cost typically exceeding $15 – 20,000. For example, an investment property purchased in Melbourne today at a modest $500,000 incurs a stamp duty TAX of $25,070. (In fact investors pay more tax than an owner occupier who pays about $21,970 tax for the same purchase). Many alternative investments/uses of capital (corporate bonds and Government bonds, shares, futures, CFDs etc) do not incur such punitive taxes which cause an immediate substantial capital loss for the investor from the day of purchase).

    Just how much investment capital would go into Government bonds if buyers were slugged $25,000 at purchase for the privilege of owning a half a million’s worth of bonds or (the VIC investment property stamp tax rate of ) $55,000 to own a million dollars worth of bonds? I can answer now. Virtually NONE. You will never see the anti NG Tax Treatment proponents mention the whopping stamp TAX cost (and hence immediate capital loss) to the property investor let alone the annual land tax grab most Governments impose on investment property owners.

    Interestingly, the anti NG Tax Treatment arguments typically highlight property investing when NG tax rules are applicable to taxpayers for alternative investments. Property is always the primary and obsessive target though.

    (By the way, conveyancing costs on purchase also represent a further but much less of a capital loss on start up, which like stamp duty costs, cannot be claimed as an expense but only as an offset against any capital gain on sale of the asset years hence).

    B. Just to make it even more difficult for the property investor, most State Governments then impose a punitive ANNUAL LAND TAX on the owners and typically this increases nearly every year as land value is re-valued. Once again this represents an effective capital loss year after year which must be recovered by the investor over time from rental income, or from sufficient capital gains(CG) at time of sale, if the investment is to show a profit. (At least land tax can be treated as an ongoing expense for annual income tax purposes but it is a punitive cost which nonetheless has to be recovered one way or the other). No such taxes are imposed on other alternative asset purchases by investors. How many investors would ever buy Government bonds, or many other alternative investment assets, if an ongoing charge equivalent to state land taxes were also levied each year on the owners of these assets on top of a large stamp duty tax at purchase?

    C. The idea of investing is to make a profit – not a loss. I do not know of any property investor that wants to make a loss year after year but I sure know quite a few that have overall lost money on their investments. Yes you will pay more annual tax with a positive geared property (if you are lucky enough to have one) rather than one which makes a loss. However, it is indisputable that the investor is always in a better financial position overall with a profitable (positively geared) property year on year than one which loses money. If you are negatively geared you are making a loss on your investment and you do NOT and CANNOT recover this loss through the current tax treatment of property losses.

    3. WHY THE NEGATIVE GEARING TAX TREATMENT IS JUSTIFIED AND LOGICAL

    Whether the ani-NG Tax Treatment proponents like it or not, property investors are running a business. That’s what owning rental property is all about. It so happens that the owners of that business will usually have income from a number of sources and expenses attached to each of these sources.

    The anti –NG proponents argue that property owners should be discriminated against and subject to a different more punitive and illogical income tax treatment than other taxed entities, many of which earn income from different sources. The anti NG proponents effectively argue that, when the property is in loss, property owners should be taxed as multiple entities, not as a single tax entity and that income and expenses from various sources should not be able to be amalgamated for income tax purposes (– unless of course the property makes a profit in which event they want the net income added to the tax entity’s other income and taxed at the marginal tax rate(as it is now)). Well they cannot have it both ways.

    Government quite correctly treats property owners as they do other businesses for tax purposes – and so they should. For example:

    ABC business produces profits or losses from the revenue less product costed allocated expenses from 5 different products and services:

    Annual Result 2011/2012
    Product A ………… large loss
    Product B……………..profit
    Product C…………….. profit
    Product D………………profit
    Product E……………….profit
    Total Business………….Small Total Loss
    Company Tax……………Nil

    The company/business is quite properly treated as a single tax entity and is taxed (or not) on the result of amalgamated income and expenses including interest expenses on its business loans.
    The Government does not say – “on a product costing basis, you have effectively made profits on one or more products in your business so we are going to pick the sub parts of your business that made a profit and tax you on each of those” ie. the small profits you made on products B to E. Rather, all income and all costs from the overall tax entity are amalgamated and the end result is taxed if it is a profit.

    The concept of taxing property owners is just the same. All income and all expenses from all sources are amalgamated and the resultant net income is taxed. The government does not treat and should not treat individuals, whether persons or companies, as being multiple tax entities for income tax purposes because they earn income from different sources and have allowable expenses from different sources. Thus, just like the concept for any business, an individual has his/hers income and expenses amalgamated and taxed as one entity. For example:

    Product A. Employment income less allowable expenses: 50,000 profit
    Product B. Property income less allowable expenses: (4,000) loss
    Product C. Other income less allowable expenses: 7,000 profit

    Total Net Taxable Income $53,000 profit

    The anti NG tax treatment brigade do not argue that business entities should be taxed based on the bits of their businesses that make a profit with the loss elements ignored. But they argue that property owners should be taxed on that basis. Thus in the above example they argue that the profitable bits should be taxed and the losses should be totally disregarded in assessing total taxable net income.

    However their arguments then become even more inconsistent and facile.

    (a). When a property business is in loss the owner must fund such losses with income from other sources – otherwise more debt must be taken on. So there is a direct link and cross over between income from other sources and the property business. The two become financially intertwined. They are not financially independent and thus should not be treated as such.
    The anti NG tax treatment proponents argue that the 4000 loss above should be totally ignored for tax purposes – as if the property business is to be treated as a totally separate tax entity. According to their logic it is OK to cross fund property losses from after tax net income from non property sources, as their proposed tax treatment would dictate (in fact there is simply no other non-debt choice to fund it). But is not OK to make an adjustment for these property business losses (which are effectively allowable cost deductions) against such other income even though such income is being used to fund the property business!

    (b) Under the current tax regime, when a property is in profit the Government does NOT tax the property profit independently of the tax payer’s other net income just as it does not independently tax net income from each other different source. The property profit is treated as any other net income and taxed accordingly. In fact when the property profit is added to other net income the taxpayer entity effectively pays a higher tax rate on that incremental income because of the tax rate scaling. If the property profit were to be taxed independently of other income, a lower tax would be applicable and in many cases for individuals, no or very little tax would be paid because of the tax rate thresholds.

    The anti -NG tax treatment proponents cannot have it both ways but that is what they are arguing for in practice. That is:

    – when a property is in profit, tax that property’s net income as any other income (and combine it with all other income sources of the tax entity for tax purposes) but totally ignore property losses that must be funded by and from other income sources;

    – treat property profits as any other earned incremental income and tax it accordingly but, for a loss making property, effectively treat it as if it were being taxed as a totally separate entity (and thus ignore the losses for taxpayer cost adjustment purposes);

    – allow (quite properly) business entities to amalgamate revenues and expenses from varying sources for tax purposes but treat individual taxpayers totally differently if their property makes a loss.

    4. Interestingly, there appears to be an abundance of people arguing against the tax treatment for NG whose sole or major source of income is from Government funded and hence tax payer funded employment. These people would have no job and no income were it not for the productive private sector of the community where all real tax revenue is generated.

    5. I think there is an incredible “envy” agenda running here. That is: “I am too lazy or stupid to take a risk running a business (like property investors do) and I do not get any or much of a tax adjustment against my employment or other income so nobody else should either.”

    6. I have dealt in property investments in the past. Not now. I would rather deal in more liquid assets that I can get in and out of quickly and not incur the horrendous taxes placed of property investors- not to mention the ongoing hassles of owning a rental property. You are:
    – taxed going in(stamp duty tax);
    – taxed on the way through(land tax and income tax); and then
    – taxed at the end (capital gains tax).
    Then when you sell the RE Agent wants a big slice of your selling price in sales commission. Hmmmm.

    Thank god for property investors because without them there would be virtually NO private rental market and the rental community would be in crisis.

    Can property investors find good alternative uses for their capital? Hell yes. They can just as easily deal in other investments and they can readily borrow for other investments as well. There are no guaranteed profits in any investment, property included. In fact the total returns achieved by many property investors after sale of their asset are frequently very low when the total average annual return over the period of holding is calculated.

    In conclusion, if the Government wants to:

    A. deter many investors from buying a property for rental , and
    B. encourage many current investors to sell off their loss making rental property investments:

    then all they need do is eliminate the annual tax treatment for loss making
    properties ( because there are plenty of investors in the loss boat).

    The end result is blindingly obvious.

    — There will be fewer properties in the high demand capital cities for rent as many of these will be sold off to owner occupiers entering the property market.

    — Rents in capital cities will inevitably increase further on remaining rental properties of the type and in the locations that renters want to live in.

    — New developments, which are frequently pre-sold to both investors and owner occupiers so the developer can get finance to commence the project, will be fewer because the investors will not be there in the same numbers to buy in. Thus new supply will falter affecting the total market.
    .

    Reply

    • November 10, 2012 @ 2:39 pm Michael Yardney

      Cam
      Thanks for that detailed and eloquent comment.
      Obviously i agree with your sentiments

      Reply


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