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- Is this the beginning of the end of negative gearing despite Labor’s promises?
- Reason 1: Government will probably (eventually) limit negative gearing
- Reason 2: Persistently low-interest rates reduce tax savings
- Reason 3: Stage 3 tax cuts will reduce tax savings
- Sophisticated Borrowers Shouldn’t Have to Jump Through the Same Hoops
- What do you mean by that?
- The current system is broken
The property industry, and investors in general, welcomed the Labor party’s announcement that they won’t change the rules of negative gearing if they got into power.
So, is this the end of the debate?
Not necessarily according to Stuart Wemyss who still has some concerns that we’re going to talk about today.
We’ll also discuss the concept that sophisticated investors shouldn’t have to jump through the same hoops that beginning investors do.
Then, in my mindset message, we’re going to talk about the fears that may be holding you back.
Is this the beginning of the end of negative gearing despite Labor’s promises?
One of the aspects of finance I discuss with Stuart is negative gearing.
What is negative gearing?
Negative gearing allows investors to offset property investment losses against other taxable income (such as employment income) to reduce their tax liabilities.
Why do people negatively gear?
The only reason that you would negatively gear is that you anticipate that the property’s capital growth will eventually dwarf its income losses.
Is negative gearing at risk?
There are three main reasons why tax benefits resulting from borrowing to invest in property will not be as substantial as they have been in the past. As such, investors should not rely on negative gearing tax benefits when making investment decisions.
Reason 1: Government will probably (eventually) limit negative gearing
The expansion of federal government debt to over $1 trillion dollars means the government must generate more revenue to service and eventually repay this debt.
One way to do that is to grow the economy (GDP) which will generate more tax revenue, even if tax rates don’t change.
Another way is to raise taxes or limit deductions.
Reason 2: Persistently low-interest rates reduce tax savings
Gross property residential rental yields typically range between 2% and 3.5%.
After allowing for expenses (such as management fees, maintenance, insurances, and so on), net rental yields typically range between 1% and 2.5%.
With interest-only investment rates starting at 2.5% p.a. (fixed rates), a property’s pre-tax income loss can range from nil to 1.5% of a property’s value (being net yield less interest rate).
This means if your property is worth $1 million, your pre-tax loss probably won’t exceed $15,000 p.a.
Consequently, your tax benefit (savings) won’t be more than $,7,050 (being 47% of the loss).
Reason 3: Stage 3 tax cuts will reduce tax savings
It was reported last week that the ALP will likely support the government’s stage 3 tax cuts which are set to become effective in the 2024/25 financial year. This means that there will only be two tiers for taxpayers that earn in excess of $41,000:
$41,001 to $200,000 = 34.5% tax rate including Medicare; and
Over $200,001 = 47% tax rate including Medicare.
Sophisticated Borrowers Shouldn’t Have to Jump Through the Same Hoops
Anyone who recently made an application to get more finance would have realized how much harder it is, how many more questions you have to answer, and how much longer it takes today.
Stuart recently wrote a great article where he suggested that sophisticated, more experienced borrowers shouldn’t be required to jump through the same hoops to get the finance that less experienced borrowers need to.
What do you mean by that?
We discuss the retail versus wholesale investor rules.
The Corporations Act makes a distinction between wholesale and retail clients (or “sophisticated investors” if being offered bonds or direct shares). A wholesale client is someone that meets either of the below two tests:
Asset test – having a net worth of over $2.5 million; or
Income test – having a pre-tax income of at least $250,000 in each of the past two years.
The Act also includes other exemptions in addition to the above including professional investor test, product value test, and small business test.
These asset and income hurdles were struck back in 1991 and are now vastly outdated.
Adjusting for the impact of inflation, the income threshold should now be over $490,000 and asset value over $4.9 million.
Wholesale clients are assumed to be financially savvy enough to make informed decisions and are able to protect their own interests.
In short, they can decide whether an investment is appropriate so there’s less onus on the provider or advisor.
Also, there are fewer obligations (on financial advisors and product issuers) when dealing with wholesale clients such as there is no need to provide a Financial Services Guide, Statement of Advice, Product Disclosure Statements, etc.
The current system is broken
The fact that someone with several millions of dollars in the bank is subject to the same assessment as someone with very little financial resources highlights that the current regulations are inadequate.
Banks must be given a robust framework but enough discretion to operate within that framework to achieve acceptable outcomes.
Distinguishing between retail and sophisticated borrowers seems to be a logical step in the right direction.
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Stuart’s Book – Rules of the Lending Game
Some of our favourite quotes from the show:
“Finance is going to be critical for us as property investors – property investment is a game of finance with some house is thrown in the middle.” – Michael Yardney
“In this environment, fear is not unusual. It’s not uncommon. In fact, I guess it’s normal.” – Michael Yardney
“Fear of change causes some people to become stagnant, and they miss out on a lot of the really great opportunities.” – Michael Yardney
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