Since it is election time, I thought I would weigh into probably the biggest policy difference at the federal level: the proposal to abolish negative gearing (NG).
The main argument against negative gearing is that it is a “benefit” for higher-income earners and property investors, and therefore unfair.
My argument is that negative gearing isn’t a “benefit” at all, and should remain in place. Let’s discuss.
What is Negative Gearing (NG)?
Firstly, let’s define our terms.
Negative gearing is the process of applying losses from one source (say from the property), against taxable income, usually from your salary. It is simply the process of netting losses vs gains across various income sources, to arrive at a net position (your taxable salary) over which you get taxed, and can result in a tax refund for PAYG earners.
Negative gearing was designed as a market-based approach to keep rents low, by encouraging investment supply.
What are the proposed changes?
The proposal is that the current losses from property should not be claimed against current income, but instead should be quarantined and carried forward to offset against future gains once the property becomes cash flow positive.
Why is it not a “benefit”?
Negative gearing can result in a tax refund for many PAYG taxpayers, but this doesn’t mean it is a benefit.
A “benefit” relates to the “unearned”. A benefit is something like the “First Home Buyer’s Grant”, or the “Family Tax Benefit” (Baby Bonus).
A tax refund when you have previously overpaid tax is not a benefit.
If Negative Gearing is a “benefit”, then so is claiming the tax-free threshold.
Removing NG essentially redefines “Net Taxable Income”
Removing negative gearing fundamentally changes what “Taxable Income” is. Taxable income has always meant adding up all gains and subtracting all losses and working out what tax should be paid on the net position.
Instead, taxpayers will pay tax a higher rate, and get their deductions on their losses perhaps decades into the future. However, due to inflation, refunds in the future are not worth as much as refunds in the present.
Removing NG means paying tax above your marginal tax rate
Removing NG deliberately over-taxes individuals in the present and gives back diminished tax refunds in the future.
The net effect is that the tax office will get the benefit of all cash flows in and then decide how you can recoup that in the future.
What might happen to property prices?
There have been two times since WWII when Sydney property prices have reduced by 10% or more: the 2008 GFC, and when negative gearing was last withdrawn in 1985.
It is likely that property prices may fall – for a time at least.
That said of course, rents will shoot up. This is because:
(a) Landlords will seek to cover their tax losses; and
(b) By scaring off investors, the supply of rental dwellings will go down, and shortages will arise.
It is less clear how markets will react on this occasion compared to the 1980s because its implementation will come off the back of several years of property price falls in the key markets.
Conclusion
The desire to remove negative gearing stems from a misunderstanding of why we had booming property markets to begin with. Markets boomed a few years ago, because we had very low-interest rates and very high population growth in our two major capital cities, not because of negative gearing.
We have negative gearing now and have soft property markets.
This article is not a commentary on politics. Nor is it an attempt to justify the purchase of poor-performing assets that lose money.
It is simply to correct some of the hype and rhetoric that surrounds this tax policy, so that once you know the facts – it’s up to you as to how you then proceed.
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