A tax policy that benefits investors more than the owner-occupier.
Ever wanted to have the ins-and-outs of negative gearing explained to you? Given the current policies in place, negative gearing is a hot topic and has become one of the most popular forms of investments in Australia, so it’s important to understand how negative gearing works.
The Australian government has spent billions in taxpayer’s money in the form of tax cuts and benefits for negative gearing — but is negative gearing doing more harm to our economy?
What is negative gearing?
Negative gearing is a type of financial investment where an investor buys an income-producing asset and the cost of owning the asset — such as property — is more than the income it generates.
Seemingly counter-intuitive, the attractiveness of negative gearing lies in the tax concessions and capital gains investors can benefit from.
What are the tax deductions and capital gains?
Current tax policies allow any net loss experienced by a negatively geared asset to be offset against the investor’s other taxable income. This results in lowered overall tax expenses.
To illustrate the power of this policy, let’s look at an example: Imagine Tom earns a salary of $80,000 a year. One day, he decides to buy an investment property worth $400,000 so he borrows $400,000 with a 6% investment interest rate ($24,000 a year). The property’s yearly expense is $5000 and the rental income is $500 a week (or $26,000 a year).
In the end, Tom actually ends up paying $1035 less tax when he holds the investment property through negative gearing. Whilst his net income does decrease by $1965, he now holds a $400,000 property that could grow significantly in value over time in a strong market.
If Tom were to sell his property for more than he paid for it, he would make a capital gain. Capital gains are taxed by the government, but if Tom were to hold onto his investment property for more than 12 months before selling it, he could be eligible to only pay half the capital gains tax.
What are the impacts of negative gearing on the property market?
Current policies making negative gearing easy are arguably unhealthy for both the Australian property market and the economy. They incentivise high-end investors to purchase more property, pushing up house prices and reducing affordability for the average Australian.
A 2015 report by the Australian Council for Social Services found over 90% of approved loans go towards existing investment homes. This means broader home ownership rates are reduced, and there’s nothing done to increase supply.
So what would things look like if these tax policies were abolished? A quantitative study recently presented to the Reserve Bank of Australia found some staggering economic impacts. It found not only would house prices soften by 1.2%, but up to 75% of households would be able to own their homes and there would be an overall welfare gain of 1.5% GDP.
Do we need to reform negative gearing policies?
In recent years, there’s been a push to abolish the current negative gearing tax policies. Moving into the most recent federal Australian election in 2019, the Labour Government proposed a new policy overhaul to ‘level the playing field.’ Under the policy, investors will no longer be allowed to use net investment losses to offset against income and the capital gains discount tax will be lowered to 25%. As Labour didn’t win that election, negative gearing policies currently remain unchanged.
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