Here we go again – negative gearing is dominating the news.
Where were all the naysayers when the RBA cash rate was at 0.1% (from 2020 to 2022) and more investors were positively geared? House prices were rising then, just as they are now.
So perhaps there are greater influences on housing affordability than simply negative gearing, like housing supply, immigration, and the capital gains discount.
But for now, let’s focus on negative gearing – which I do believe can be improved.
As I mention in this discussion with Terry Ryder – Quarantining might provide a balanced solution. But before I explain how, let’s backtrack a little.
What is Negative Gearing?
Negative gearing enables property owners to deduct certain expenses related to their investment properties from their taxable income. This approach allows them to reduce their tax liability while hoping the property’s value will increase over time.
When the policy was first introduced in Australia in the 1930s, I doubt it was intended for investors to claim losses on portfolios of 30 properties, for instance. While such investors are a minuscule percentage, they do exist.
I also don’t believe this policy was designed for those able to purchase a $20 million property in Sydney’s Vaucluse or Melbourne’s Toorak, for example. Yields on super luxury homes tend to be lower, resulting in higher negative gearing benefits.
According to a recent article in the Australian Financial Review, less than 50% of investors were negatively geared, based on ATO figures from 2020-2021.
Now, that figure has likely increased since our record 13 Reserve Bank interest rate rises, but it does beg the question – what about the additional revenue generated from positively geared properties?
Just like losses can be negatively geared, when the rent from a rental property exceeds its expenses, that profit is ADDED to the investor’s taxable income.
So, do those advocating for the abolition of negative gearing really want to forfeit the tax revenue generated from positively geared properties? Surely, you can’t have it both ways?
Capping Negative Gearing to Two Properties
Some suggest capping negative gearing – for instance at two or three properties per investor. While this may sound appealing, I believe it would be challenging to administer.
What happens if you own two positively geared properties and two negatively geared ones? Do they balance each other out? What if you have shares in a fund that holds negatively geared properties?
Investors might also use multiple entities, such as trusts or companies, to hold properties, making it difficult to determine whether they exceed the two-property limit.
Approximately 90% of property investors own one or two rental properties.
Many who negatively gear do so with the goal of becoming self-funded in retirement – a factor often overlooked in discussions about the costs of negative gearing to the government in terms of lost tax revenue.
My Solution – Quarantining
From what I can see, the main concern surrounding negative gearing appears to be the offsetting of losses against an investor’s personal income tax (rather than against the income solely derived from the property itself). It’s worth noting that the same tax strategy is used for share investments.
In my view, the losses that property investors claim should be split into two categories.
First is the Running Cost of owning an investment property – things like land tax, management fees, strata levies, repairs, maintenance, and depreciation.
A second loss can arise when rental income falls short of interest repayments. Let’s call this your Holding Loss.
Now, I don’t think anyone would deny that Running Costs are a normal day-to-day expense associated with running an asset or a business.
And I believe that Running Costs should continue to be deductible against the name in which the asset was purchased – (ie the investor’s wages, if the property was bought in their name).
However, the Holding Loss could be Quarantined until the sale of the property and used to offset the investor’s capital gains tax.
Put simply, if you have rental income of $30,000 per annum, and mortgage repayments of $35,000, the $5000 loss would be quarantined until the sale of the property – thereby reducing your capital gains tax implication.
Quarantining these losses would help align tax incentives with long-term property ownership, potentially stabilising the market and reducing property flipping for quick tax benefits.
The only downside I can see is that some investors might be deterred from buying rental properties if they cannot offset losses immediately, potentially leading to a decrease in rental supply.
To mitigate this, I would still allow negative gearing in its current form for brand-new properties and also grandfather any existing arrangements.
My version of Quarantining losses offers a balanced solution to the negative gearing debate.
I believe it could help maintain the integrity of property investment while addressing concerns about housing affordability and inequitable tax benefits.
In fact, I asked ChatGPT what it thought of my proposal – and it agreed. Check this out.
