Negative gearing has been called a lot of things in the media lately…
- A tax break
- A party
- A rort
- Out of control
It shows no sign of abating either. On the lead up to the Federal Budget, TV personalities like Waleed Aly throwing his opinion into the mix, and whole issue was very quietly omitted from the 2016 Federal Budget despite all this hype. So there’s plenty of ammunition out there for people to attack negative gearing. So far, all the arguments against negative gearing that I’ve read are drastically oversimplified into winners and losers, landlords and tenants, law abiding citizens and tax avoiders.
Don’t buy into it!
My colleague Daniel Causerano has written a fantastic piece on negative gearing here which I’m hoping to build upon below (Negative Gearing Part 2). You should check it out if you haven’t already. Have you read it yet? Good. Then you’ll know that the term negative gearing refers to the practice of using losses from rental properties to reduce your taxable income in a given year. Now on the surface that sounds like a fantastic deal but consider the following…
1. There’s risk involved:
People will invest in property for capital growth or with the view to turn a profit eventually. There’s always a chance that a property may never appreciate in value or may never turn a profit, the same as any investment has the potential to go bad. It is not the role of the tax system to make one class of assets seem more preferable than another. By limiting losses on rental properties and not, for instance, share portfolios it would do exactly that. However, nobody in their right mind would seek out loss making investments purely for the tax benefit because…
2. A tax loss isn’t worth what you pay for it:
Let’s say my income is $50,000 and my tax rate is 30%. My tax bill for the year comes to $15,000. Now let’s pretend I have a rental property that makes a loss of $10,000 for the same year. I offset this loss against my $50,000 income to arrive at $40,000 income and my tax bill is now $12,000. I’ve saved $3,000 in tax, but had to make a rental loss of $10,000 to get it. So my after tax loss is $7,000. By itself, not a compelling argument for investing in real estate.
3. It eats into your other income:
Referring back to the above example… My after tax loss of $7,000. This isn’t just a loss ‘on paper’ in order to reduce my tax, it’s real. It represents the excess of rental expenses over rental income including any tax benefits I received. I have to cover that loss out of my other sources of income or I go broke. Basically, people with higher disposable incomes are better able to cover their investment losses. This is nothing new, but it is often a limiting factor when considering any investment.
The largest expense for any negatively geared rental property is interest on the loan. Without a loan from the bank, an investor may have never purchased a rental property. To say that negativegearing is exploited solely by wealthy investors isn’t at all accurate. If I was a wealthy investor wanting to buy a house (I’m currently not either), why would I want to go incurring interest when I could buy the house for cash? Certainly not for any tax benefit (Refer to point 2).
5. So why do it?:
“Because property always goes up in value right?” Wrong. In fact, I would bet that most people who’ve made money investing in property over the years have also lost some. In fact the reason that house prices are so “sticky” by nature is that people are guided by this belief of ever increasing property prices. The commodities boom only cemented this belief in people and as people started getting wealthier, where do you think most of them parked that wealth? You guessed it, Property!! This drove prices upwards. Let’s not also forget that around the same time, the Banks were lending to anyone with a pulse.
So where am I going with all this you ask?? Well firstly, negative gearing isn’t all rainbows and unicorns as the media and Bill Shorten might have you believe. There are material sacrifices that need to be made that far outweigh any tax benefit.
Secondly, there are far more significant drivers of property prices than negative gearing. Factors such as land supply, household incomes, and access to credit (bank lending) play a far greater role. So before attacking negative gearing, ask yourself what else drives house prices?
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