The truth behind Negative Gearing reforms

With the federal election looming, talk about what would happen to negative gearing under a Labor government is growing louder by the day. Leader of the opposition Bill Shorten has promised substantial reforms to the current system with the intention of making properties more affordable for first homebuyers. So, what are these changes and what would they mean for investors?

First, let’s look at what negative gearing is and how it works. ‘Gearing’ refers to an investor borrowing money to buy an investment property, and their purchase can either be positively geared or negatively geared.

‘Positive gearing’ is when the income an investor earns from a property outweighs outgoing costs – basically, when the rental return is higher than interest repayments, strata fees, property maintenance and other costs incurred.

In contrast, ‘negative gearing’ means the outgoing costs are greater than the amount an investor is making from the property. Under current negative gearing laws, investors can claim these outgoing funds as a loss on their annual tax return, allowing them to reduce their taxable income and, subsequently, their annual tax bill.

In theory, a property that’s positively geared might sound like a better investment, but negatively geared properties tend to be worth more in the long run. This is because positively geared properties are typically in regional areas, while negatively geared investments are more likely to be in locations that have greater capital growth – like inner-city suburbs – helping to cover any losses incurred.

If elected in May, the Labor party plans to limit negative gearing to newly built housing. It’s as-yet undecided when this new policy would come into effect but speculation places it around mid-2020, giving investors time to plan ahead. The reforms will be grandfathered, meaning negatively geared investment properties purchased prior to commencement date will be exempt from the changes.

As well as reworking negative gearing, Labor plans to amend the capital gains tax (CGT), discount (which currently stands at 50%) to 25%, meaning when investors sell assets such as managed funds, shares and property, 75% of the profit would be taxable. Like the negative gearing changes, this amendment would be grandfathered.

Despite some industry apprehension about what these changes will mean, experts are suggesting the impact won’t be significant.

In an Australian Financial Review article published last November, Tax Institute senior tax counsel Bob Deutsch pointed out that a loophole will still allow larger investors to offset expenses against multiple investments, including shares as well as real estate.

“You have to be positively geared in the aggregate across your investment portfolio,” he told the paper. “If you have a range of investments and some are positively geared and some are negatively geared, you can mix and match them together.”

And even if an investor is no longer eligible to claim repayments, it’s likely the deduction on their tax bill isn’t hugely significant anyway. An ABC news article last December provided the following example:

Say you earn $100,000 annually and pay a bit less than $25,000 in tax per year.

You buy an investment property which earns $50,000 a year in rent. If your interest payments on that property are around $60,000 a year, you can deduct the difference of $10,000 from your taxable income.

Which means your taxable income would drop down to $90,000, which would reduce your yearly tax bill to roughly $21,000.

Plus, investors can still claim a range of other deductions aside from the interest on their repayments. The ATO has an extensive list that includes advertising for tenants, council rates, strata fees, maintenance and more.

There are other positives, too. In a market where prices are cooling and fewer investors are buying properties but tenants still need homes, rental yields will rise and vacancy rates will be low, offsetting any lost tax breaks.

Ultimately, tax breaks should be a bonus of property investment, not the reason for doing so. By focusing on long term equity growth and buying in strong areas, investors can continue to thrive.

 

 

Disclaimer: The information in this publication and the links to further information within it are provided for general information only and should not be taken as constituting professional advice from Kay & Burton. You should not rely on the accuracy of this information and should seek independent legal, financial, taxation or other advice to check how any of this information relates to your unique circumstances. Kay & Burton is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, or from our website.

 


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