Those negative gearing blues

Around budget time each year, and whenever tax reform is discussed, property investors shudder at the thought of the abolition of negative gearing.

At the federal government tax summit last year, Grattan Institute economist Saul Eslake called for changes to negative gearing, arguing it provided $4.5 billion each year to affluent Australians and reduced the supply of affordable housing.

“We’ve got a personal income tax system that rewards accumulation of wealth through borrowing and speculating and penalises the accumulation of wealth through working and saving,” he said.

Not that long ago ANZ Bank’s Phil Chronican took aim at negative gearing, claiming the tax break was leading to an unhealthy focus on housing as a means to get rich, while pushing property prices to unaffordable levels.

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 that push up property prices. It is sometimes argued that it would be better to use revenue forgone through negative gearing to build more “affordable” homes.

A quick primer:

A property is negatively geared when the costs of owning it – interest on the loan, bank charges, maintenance, repairs and depreciation – exceed the income it produces.

Since the costs of producing an income are generally deductible against the taxpayer’s other income, property investors can effectively offset some of the interest expense against their wages. This has made some argue that other, less fortunate taxpayers help these property investors meet their costs.

Why would anyone go into a business deal that is expected to make a loss?

Generally it’s because property investors hope that their income losses will be more than offset by their capital gains when they eventually sell their properties. And in Australia capital gain is not taxed unless you sell your property, and then it is concessionally taxed – again evoking the argument that it favours wealthy landlords.

Of course negative gearing is more favourable for taxpayers who earn high incomes.

Imagine an investor had excess interest expenses of $10,000. If he were on a marginal tax rate of 15¢ in the dollar he could use his loss and reduce his tax by $1,500. But a taxpayer in a higher tax bracket, one who pays 30¢ in the dollar tax, could reduce her tax by $3,000.

So the benefits of negative gearing are greater the more you earn and the higher your tax rate.

What’s the fuss about?

In our modern society we pay our 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 cheaply.

When the government can’t supply enough public hospital beds, privately run hospitals step up to the mark and not only receive tax deductions for their business loans, but also allowances to subsidise 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 like you and I save our deposits, 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.

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 buck.

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 its 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. These are people like you and me who have chosen to run our own little property investment businesses.

If we set up a dog wash business or a restaurant, we’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?

Hmm… something for the government to think about.

 

Michael Yardney is the director of Metropole Property Investment Strategists, a best-selling author and one of Australia’s leading experts in wealth creation through property. For more information about Michael visit www.metropole.com.au and www.PropertyUpdate.com.au.

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