Negative gearing needs some limits

25 June 2016

Tax reform debates in this country have been varied over time.  But it wasn’t really until this year that anybody touched off a serious debate on a tax arrangement known as negative gearing.  And it generated quite a bit of debate.

Basically, negative gearing is a practice by which you can buy an investment property and claim any loss from it as a tax deduction, assuming that the rent paid by people living on the property is less than the cost of having it.

This practice of negative gearing has existed for many decades.  It was abolished for a few years during the 1980s, but restored after a massive campaign from the real estate industry, which argued that the absence of negative gearing had caused a shortage of rental properties and a rise in rent prices, especially in Sydney.  Mind you, it was pointed out that there didn’t seem to be similar problems in other big cities, so might the whole argument about negative gearing have been more a “Sydney thing” than anything else?

To understand negative gearing, you have to understand what happens when you buy a property, whether to live in as your home or to rent out to someone else.  You’d think that surely people buy a property because it’s where they want to live.  But for whatever reason, many people buy properties purely for investment purposes, and let others live in them and pay rent for living there.

Regardless of whether you buy a property to live in or rent out, unless you’re very wealthy, you’d have to get a loan from a bank or some other lending institution to do so.  And when you get that kind of loan, whilst gradually paying it back over time, you also pay interest on the loan, which is added to what you pay back.

But unlike when you live on the property that you buy, apart from paying interest, you normally have to pay other expenses associated with a property that you invest in and rent out to someone else.  These can include things like maintenance of the property, and body corporate fees if the property is an apartment or a flat.

When you rent out a property, ideally you’d want the rent to cover the interest that you pay on it, plus any other costs associated with owning the property – these can be referred to as running costs.  But what happens when nobody will live in it unless you charge rent which is less than the running costs, meaning that you’d lose money on the property?  It’s true that property prices, especially in big cities, are generally thought to be always rising, which could offset any loss from running costs, but for now I won’t go into that, to avoid complicating the argument, because not all properties in all places rise in value over time.

Nonetheless, the possibility of a loss on an investment property is where negative gearing comes in.  If the rent paid to you is less than the running costs on your property, you can claim the difference as a loss in your income, and if your income is lowered, you pay less in the form of income tax.  Therefore, the loss on your property can be a tax deduction.

For argument’s sake, you might own an investment property with running costs of $600 per week, but you only get $500 per week in rent, hence a weekly loss of $100.  With negative gearing, you can take that loss of $100 out of your regular income, and therefore reduce your tax.

Critics of negative gearing argue that this kind of tax arrangement costs Australia billions of dollars every year in lost tax revenue.  Defenders argue that most people engaging in negative gearing aren’t wealthy at all, although they don’t necessarily explain how it helps people to actually own their own homes.  Indeed, some defenders have argued that most people engaging in negative gearing earn less than $80,000 in annual income – the equivalent of about $1,540 per week.

But a new issue arises from mentioning that amount of $80,000.  Australia’s income tax system has several thresholds, meaning levels above which you pay more tax, and one such threshold sits at $80,000 – if you earn more than that amount, you pay a higher rate of tax.  Therefore, as an example, if you have $1,600 in weekly income and you lose $100 per week from an investment property, you can take that loss of $100 from your income, thus reducing your income to $1,500 per week – which would put you below that threshold of $80,000 and enable you to avoid paying a higher rate of tax.

This arrangement looks like a form of tax avoidance.  Even if most people engaging in negative gearing aren’t exactly wealthy, it looks like a rort.

Moreover, there’s nothing in tax law stating that you can’t claim a tax deduction if you own more than one investment property.  It’s probably fair to argue that, as individuals, most investors only have one such property, regardless of whether they also own a property in which they live or they pay rent themselves to live on some other investor’s property.  But to my knowledge, negative gearing is open to all investors, whether they have one property or a dozen properties.  And given that you’d probably have to be extraordinarily wealthy to buy lots of investment properties, it arguably wouldn’t sit well with taxpayers to know that most of the benefits of negative gearing are going to wealthy people who don’t need them.

Also, despite concerns about housing shortages, I’ve seen disturbing stories about empty properties, with countless houses and units having nobody living in them.  How can this be happening?

I believe that negative gearing should stay, because most people engaging in it aren’t wealthy, but it needs some limits.  Taxpayers shouldn’t be propping up wealthy people who least need or deserve this kind of tax break.

 

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