Negative Gearing and Capital Gains Tax (CGT) discount
Is negative gearing and the CGT discount the problem? It is fair to say that many firms and commentators and polarized on this issue. Everyone has an opinion, many come from a position of the ill-informed. There are so many considerations here it is remiss of anyone to jump on the band wagon and let fly an opinion with fully understanding the consequences.
Prices are 18% above trend leading to concerns over a bubble. The fact is the Australian regulatory system is one of the best in the world, our population growth is excellent, and both of these points will limit the risk of an actual bubble bursting. Banks in Australia however are more exposed that almost all other banks around the world, exposed to figures that tend to suggest 1.5 trillion, with predatory and fraudulent lending allegedly being rife according to some. The 1.5 trillion, by some estimates equates to 94% of GDP.
The more pressing point though, for you the reader is housing affordability.
In its current form, negative gearing has been around since July 1987, with a brief stint prior. Previously to that, since the tax act of 1936, losses could only offset income generated from the property, not income from wages or personal exertion.
This topic often comes up, on the back of a money grab amidst an election or budget, to make up for, as some would say, the poor management of funds during the previous year, with figures being thrown around of CGT concessions and negative gearing costing the Government almost 12 billion a year it is no wonder the idea is being tossed around, by labor anyway. It is more the case that low interest rates (low cost of debt) that has led to hikes in property prices.
To argue that negative gearing should go is usually either politically motivated or coming from a position of being naïve or ill informed, (as one commentator put it). The RBA even, has stated that the ‘ability to deduct legitimate expenses incurred in the course of earning income’ is an “ important principle”. Any self-employed person would agree with this principle in the course of their business. Investing in property is like a business, you need to take it seriously, weigh up opportunity cost, conduct a SWAT analysis, and implement a considered and planned course of action.
The property Council of Australia in my view, suggest that undersupply is the problem, not negative gearing
Let’s look at a simple explanation of negative gearing before we get further stuck into the arguments for and against.
Negative gearing is equal to rent less all outgoings, which ends up being the cost to hold the property. If outgoings, like mortgage repayment, rates, insurance, agents commission to manage the property, and any body corporate expense and maintenance is greater than the income, the property is known to be negatively geared.
A 400k-investment property:
Rent of $17,000
Managers fee $1,309
Equals -$4,489 pa
The property is negatively geared in this example, because there is an out of pocket (loss) of $4,489 pa. This loss can be reduced by depreciation, but let’s keep the figures simple by ignoring depreciation for this exercise.
If the investor is on a taxable income of $80,000 the new taxable income would be $75,511. The loss has reduced the taxable income possibly leading to a tax refund. The investor could ask their employer, if payg to reduce tax withheld from their pay on assist with affording this loss.
A CGT discount of 50% applies if the property is held for more than 12 months. So any profit (capital gain) on the property would only have capital gains tax applied to 50% of the gain.
Someone could move out of their house however, and rent it out, and providing it was purchased originally as a principle place of residence, it can remain CGT exempt if rented out for less than 6 years. * (rules apply to CGT exemption on a house)
If we were to look at the negative side of negative gearing it is that it has also inadvertently discouraged more responsible investment, because many investors have purchased a property for specifically the negative gearing benefit. They purchased a property, usually skewed toward ‘new’ property to reduce their taxable income. If this was the only reason to have purchased the specific property then that is plain dumb.
This practice of just buying a property for the negative gearing aspect, I optimistically would like to think has been less prevalent in more recent years with the emergence of professional property advisory services, positive cash flow focused properties, consideration of a more balanced approach of investing and better education on risks associated with property and necessary importance being placed on research, sadly it is not as much the case as I would like to think.
Negative gearing has, forgive the pun, also negatively impacted on more intelligent practices (in regard to ‘new’ property in particular), such as carrying out good research, avoiding property marketing companies and their glossy brochures and inflated claims, seeking advice, and fact and figures analysis when determining which property may be worth considering. Reducing the risk typically associated with speculation can be better achieved through these more intelligent practices.
It is also a problem to the extent of it encouraging speculative property investment, such as ‘would be’ and ‘want to be developers’ out bidding young families and first home buyers at auctions of any stock where the land would allow for subdivision or demolition of the home to pave the way for building 2 or 3 dwellings in it’s place. If it was abolished on these subdivision speculative properties, it would reduce the amount that could be made for the vendor, is that fair?
Most first home buyers and young families and anyone for that matter who face a ‘lack of affordability’ problem would probably agree that negative gearing at the very least should be treated as it was designed, which was to be simply a bi-product or fringe benefit of purchasing a property in a non-speculative manner to encourage wealth creation, i.e. a capital growth focused property based on a buy and hold strategy.
A capital growth focused property is one that is purchased for a long-term hold. As the value grows, in a good market, the value often increases at a faster rate than the rental income on it can increase, this creates a lag period for rents to catch up, therefore creating a situation of someone being out of pocket in holding the property, so the biggest and most obvious benefit is that it helps enable people carry the debt attributable to building a future for them selves.
If people are intentionally limited by any Government in being able to affordably to build wealth through property, and by default, being more limited to just shares, it is counter intuitive, it is destructive and it is short sited, but hey that’s politics for you.
What’s wrong with being able to build on the ‘Australian dream’ of not just owning a property but also avoiding losing the property in retirement by having to sell it to access the equity and down size, due to insufficient investment assets being accumulated?
If negative gearing was abolished, it is the belief of many that it will impact on the rent people will pay, as the market rate would shift upward to compensate owners. State Governments have moved away from providing social housing, landlords provide a service, if investors moved out of property there would be less property for tenants, rates would then shift up.
The flow on affect would be the negative impact on tenants’ lifestyle, as many tenants would be forced to move to more affordable accommodation, (the accommodation might be substandard to their lifestyle). Some say rents increasing would be a myth, and they base it on the removal of negative gearing in the 80’s, it is absurd to use 30-year-old data to form a clear picture of what will happen 30 years later. In fact, REIA president Neville Sanders stated ““The Henry Review, released in 2010, recognised that the current tax arrangements placed downward pressure on rents.”
Sanders went onto make additional comments about the “current tax treatment of negative gearing” and the “capital gains of residential property is exasperating housing affordability” by stating, “This is simply not the case. Indeed the public interest is being served and advanced through the current taxation arrangements,”
He said that ‘negative gearing and the CGT discount are not driving excessive investment in housing but instead they are adding to housing supply’
He also has stated around May 2016 that if there were changes to negative gearing it could in fact make the problem worst with affordability, by reducing supply.
The Government would effectively be responsible for vandalizing people’s living standards. The more macro affects are more problematic, especially if it was applied to all property, as it would affect the National economy even more drastically. The construction industry employs over 100,000 people, and is a large percentage of GDP. Without negative gearing the implications could be massively destructive to these people, and to the National economy.
If negative gearing was ever applied just to new homes, it would be a boon for building companies, and developers, but with every primary market, there needs to be a secondary market. Once the ‘new’ property has been purchased, it simply won’t sell for what it could have done previously, as there would be a limited secondary market, investors would be less interested in buying these ex-new properties, as there would not be any negative gearing benefit. Investors would just keep buying more new properties potentially. The Government would have succeeded in reducing the capital growth potential on these properties, but it is the inner ring around the CBD of any city where this won’t help, prices in inner suburbs on houses needs to be reduced to assist with affordability, not some ‘new property 40km from the CBD.
A recent survey conducted by the REIQ suggested that 79% of respondents would exit the property market with the abolition of negative gearing. I believe that it would have massive ramifications to the prices for established and new properties, most properties, if not all, will lose value in the medium to outer ring, particularly if the removal of negative gearing is applied retrospectively, blue chip properties would be more resilient.
Investors would not buy established property, if negative gearing were only applied to new properties moving forward. Imagine all those baby boomers relying on the accumulated equity in their property for downsizing. The equity in the Y Gen parent’s properties would reduce; there would be less equity for those parents to leverage off to help their children.
People with adult children can currently assist their kids if they have equity in their home, assuming they can obtain a loan. When property prices fall if negative gearing is abolished or changed to only apply to new property, that equity that is there will be eroded away. According to a report by the Grattan Institute house prices will fall by 2 per cent. I think this is conservative. Revenue to the Government, according to ABS data would reduce significantly, from less stamp duty, less capital gains tax, less council rates.
There are some influences that are not necessarily the prominent influences in the market but they do count, as to why the abolition of negative gearing is not the right solution. There are some that are afraid of taking action toward their future and expect the Government to look after them because they paid their taxes all their lives. They forget that taxes are for roads and schools and health and safety services not just for a pension.
Negative gearing contributes to property being attractive which in turn supports the Australian economy. Punishing those that are trying to make a future for them selves is arguably wrong. Negative gearing could be used by first home buyers also, it improves the ability to service a loan, so they could purchase it, get a foothold on the property ladder, leverage off its growth over a period of time, then either move into it or use the growth in equity to buy in a different area, a better area perhaps than what they otherwise could have previously.
The Property Council of Australia supports this view of negative gearing assisting first homebuyers “as a more economical option”
The Government should build more rail links and roads, to and infrastructure in outer areas, providing more improved access to job nodes. It is a fact of life that to live in a closer area to the CBD you have to pay for it.
70% of all property is purchased for owner occupied purposes; prices are driven by emotion more than the influence of negative gearing.
Prevent property speculators from using negative gearing. Stop anyone from gaining from negative gearing and tax benefits. Not holding property for longer term.
Only have CGT reduction of 50% applicable for people who hold property for more than 5 or even 10 years, eliminating the speculative nature of property investing. A suggestion of 25% reduction across the board has been floated, but it will not eliminate speculation to the degree that it would if we have the reduction apply only after 10 years.
Lets not forget that low rates, negative gearing is reduced. On established property negative gearing benefits such as tax savings from depreciation are less than new properties as well. So other than the interest expense being claimed as a tax deduction on investment purpose debt, on established and new properties, there is less to be had on established properties typically.
Remember also, if someone never sells an investment property, the CGT debate is irrelevant. They would never pay CGT anyway.