Lately negative gearing for property investment has come under siege, with calls to scrap this tax incentive for property investors.
Just to make things clear…negative gearing is leveraged speculation whereby a speculator borrows funds to buy an asset, but the income from the asset fails to cover the interest repayable on the loan.
In Australia, the interest on the loan may currently be offset against other income thus facilitating a tax deduction.
Punters may therefore be compelled to speculate in assets which generate a cash-flow loss in the hope of a future capital gain. This is true in shares and particularly the case in residential property.
It is very fashionable at the moment to blame high property prices in Australia squarely upon the practice of negative gearing
The theory is that the prevailing laws should be scrapped, speculators would exit the property market and the values of properties would decline markedly.
This may or may not be the case.
Today, let’s take a look at the other side of this argument, and particularly why the Government has not simply pressed ahead with this course of action.
Why doesn’t the Government simply scrap these tax laws?
Well, they tried to.
In 1985, the Labor Government rescinded the negative gearing
tax laws and yet was forced to reintroduce them just two years later in 1987 (Labor then suggesting that the new capital gains tax
rules should instead act as a deterrent to speculators).
The main problem facing the Government, so the argument goes, was a shortage of available rental properties.
Some commentators like to cherry-pick numbers and suggest that in some cities rents did not increase between 1985 and 1987. That may indeed be true, but also in some cities (namely Perth and Sydney) rents absolutely sky-rocketed.
It is easy to blame incessant lobbying from the real estate industry for the re-introduction of the negative gearing
incentives, but the counter-argument is that much of the backlash actually came from tenants in those cities who were shocked by the spiralling rents.
Social housing funding
The other argument for scrapping negative gearing
rules is that the Government could save itself billions in tax revenues. Again, this is partly true, but there is a flip side, and this is that social housing funding would presumably be increased.
Between 1985 and 1987 the numbers on the NSW social housing waiting list increased alarmingly by around 40% from fewer than 110,000 to 140,000, a trend that was immediately reversed upon the re-introduction of the previous ruling on interest deductions.Of course, many other countries do not have equivalent negative gearing
tax laws, but in some cases this may equate to a higher percentage of the population (particularly in certain socialist countries) becoming reliant upon the state for social housing, an outcome which brings with it its own hefty costs.
4 reasons property investors don’t fear the gear
So why aren’t property investors more worried about the incentives being abolished? Here are 4 reasons:
1 – Lack of retrospective application
In 1985, the new laws were not made retrospective so existing property investors were not impacted.
2 – Compensating laws?
At the time of the scrapping of the negative gearing
rules, the Government was seemingly aware of a need to introduce other incentives and thus introduced a 4% capital allowance on the construction cost of new buildings to be offset against new income.
The idea was to encourage investors to invest in new properties to alleviate the rental property shortage, but overall, it would probably be fair to say that the allowance was ineffective.
3 – Lower interest rates
in property became very popular in the 1980s when interest rates were significantly higher than they are today.
Whether the structural shift to lower interest rates since 1990 proves to be a permanent one remains to be seen, but negative gearing
rules are of diminished importance to investors when interest rates are lower as they are now.
4 – Increasing rents
If negative gearing
laws are abolished, rents would probably
increase, which would act as some compensation for property investors.
It seems unlikely that they would be scrapped outright and overnight, but they may well be phased out over time.
Smart investors do not worry unduly about changes in political and tax regimes but instead align themselves to the shifting markets.
There will always be underperforming and outperforming assets, and educated investors simply aim to move with the changing times.
[sam id=29 codes=’false’]