Q&A: What are the options with negative gearing?

Negative gearing is a hot topic in federal politics at the moment, but what are the options when it comes to this contentious tax issue?

What effect will they have on homeowners and investors?

Turnbull Government’s current policy

The Australian Tax Office defines the practice in the following way:” A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings.”

“The overall taxation result of a negatively geared property is that a net rental loss arises. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income (such as salary, wages or business income) when you complete your tax return for the relevant income year.”

While the Turnbull Government hasn’t announced any formal changes to that policy, it is considering capping the dollar amount of losses that taxpayers can claim.

However, the prime minister has ruled out changes to capital gains tax for property, which does affect investors who negatively gear their assets.

Keeping the status quo

Chief Executive of Industry Policy at the Housing Industry Association Graham Wolfe says “negative gearing should not be changed because it will distort the market in many ways and at many different levels”.

“If you remove negative gearing from rental properties it will effect mums and dads on lower incomes who rely on negative gearing to make the investment equation work.”

“Negative gearing is about creating opportunity to invest and increase the (housing) stock at the same time – the benefit is, it creates extra rental properties that otherwise wouldn’t be there,” he says.

The HIA says that increasing housing stock, improving the availability of land, and property tax all need to be looked at before negative gearing is reformed.

On housing affordability, the group says first home buyers should be given the option to temporarily dip into the superannuation savings to pay for a deposit.  Wolfe says this could allow first homebuyers to get into their first property sooner without affecting their super in the long term, provided they are able to pay back the funds they use for a deposit.

Has negative gearing ever been abolished before? What happened?

In July 1985 the Hawke Labour Government abolished negative gearing for future rental properties, effectively quarantining losses from owning a rental property.

In 1987 negative gearing was reinstated. So what happened to prices?

This is what happened when negative gearing was restricted in the 1980s.

Wolfe says that while the rent picture did vary city to city when negative gearing was abolished, it did put pressure on the rental market.  If the policy was scrapped again, he says renters could face much higher prices.

“If you scrap it (negative gearing), you’re going to have fewer investors in the market. Fewer investors in the market means greater pressure on rental stock and prices will go up,” he says.

CoreLogic RP Data research analyst Cameron Kusher isn’t so sure.

“The quarantining of negative gearing in the mid 1980s was only for a short period and doesn’t really tell us all that much about what we can expect this time round,” he says.

“Inflation rates were higher then, interest rates were higher and finance was not as readily available as it is nowadays.  In Sydney, home values increased by a cumulative 25.1% over the period from June 1985 to September 1987, in Melbourne values rose by 22.2% and in Brisbane values rose by 8.7%.”

Labor’s proposal: New homes only

Labor Leader Bill Shorten recently proposed limiting negative gearing to just newly-built homes, with Labor’s policy not coming into effect until July 1 2017. This means current property investments would not be affected.

Properties purchased after this time would also find the capital gains halved, under Labor’s proposal.

Unsurprisingly, the prime minister isn’t a big fan of Labor’s policy.

“The Labor Party’s negative gearing policy and its wind-back on the capital gains discount – its increase in tax on capital gains – is a very dangerous one. It’s been very, very poorly thought out,” says Malcolm Turnbull who insists the plan would wipe 10% off the value of Australian homes.

Are there other policy alternatives?

The Australian Council of Social Services has its own vision for what negative gearing could look like:

“ACOSS proposes that ‘negative gearing’ should not be allowed for new investments in property, shares and similar assets. This means that tax deductions for ‘losses’ on new investments should not be claimable against an individual taxpayer’s other income, including wages,” the advocacy group says.

“To protect people who made investment decisions under the existing rules, existing investments would not be affected: the current rules would still apply until the property is sold.

“We also propose, consistent with the Henry Report, that the 50% discount on individual capital gains be reduced and that the same tax break should apply to other investments such as bank accounts and rents received by housing investors. This would remove the tax bias in favour of speculation in the values of assets such as housing and shares.”

The Australian Greens would like to see negative gearing scrapped for new homes purchased on or after 1 July 2015 with a provision to grandfather existing arrangements for current investment properties.

The party says the funds saved through getting rid of negative gearing should be used to build 7000 new homes for the homeless by 2020 and a further 7500 homes for social housing over the next four years at an estimated cost of $1.88 billion.

The parliamentary budget office estimates that scrapping negative gearing could save up to $42.5 billion over a decade from the 1.3 million taxpayers who currently claim the tax concession.

How would these policies affect mum and dad investors?

Economic modelling of Labor’s plan undertaken by the Australian National University’s Centre for Social Research and Methods shows the policy could slow the pace of house price growth while boosting the construction of new homes.

Labor’s plan is “potentially the biggest housing affordability policy the country has seen,” the ANU paper says.

LJ Hooker CEO Grant Harrod takes a different view and says the company “has concerns that negative gearing has become an election platform”.

“Property investment is central to an individual’s, couple’s or family’s wealth accumulation, helping to fund major milestones in life.  As we’ve seen recently, property is a very solid investment option,” says Harrod in a recent opinion piece on the issue.

“Changing negative gearing legislation will lead to a structural change of the real estate market.”

The Turnbull Government is currently considering capping the amount taxpayers can claim on negative gearing which may reduce the practice, according to Kusher.

“Obviously capping the losses would reduce the amount by which property investors can reduce their taxable income, therefore property investment would be less attractive for some,” he says.

“You might find that those who own many investment properties might look to sell some of their excess property because outside of any capital growth there is little tax benefit in holding so many properties.”

How would these options affect investors with deeper pockets?

A recent survey of 1700 investors with properties managed by LJ Hooker found that 31% would sell all or part of their property holdings if the system was abolished or restricted.

Harrod says Labor’s plan “would likely create panic purchasing with a rush of investors buying up existing properties in the six months before implementation”.

“It would create a build-up of demand followed by a drop-off in sales and, as we know, a sudden spike is never good for markets.

“Such activity hurts everyone from investors to first home buyers and even retirees planning to sell to fund what should be the best years of life.”

But Kusher cautions against such predictions.

“The truth of the matter is that no one really knows what the impact will be we can only really speculate … negative gearing had been removed in the past but only for a short period so it is really difficult to know the overall impact,” he says.  

“What we do know from housing finance data is that currently very little new housing stock flows to investors (around 22%).  The (Labor) policy aims to re-direct investment to new housing stock however, you can’t just assume that investors will make this leap.”

[Source:- Realestate]