Negative gearing – a bizarre Australian tax break that’s under attack

Today’s post focuses on some technical tax jargon from the Australian system, and while this might sound tedious to you non-Australian readers I will try to keep it high-level so that we don’t have to get stuck in legislation…

What sort of picture do you use to illustrate a boring tax break? Evidently this, which was one of the first images that appeared in a Google search. Strange.

What sort of picture do you use to illustrate a boring tax break? Evidently this, which was one of the first images that appeared in a Google search. Strange.

What is negative gearing?

Negative gearing is essentially a tax break given to Australian taxpayers who invest in property where the costs from owning the property can be deducted from the property’s income (rent). If the costs are more than the rent, the property is considered “negatively geared” (i.e. it makes a negative income due to the gearing or borrowing taken on to buy the property), and this excess can be offset against other income (e.g. salary and wage income) which should result in a tax refund.

I can’t be bothered investigating the stats, but there are millions of negatively geared properties in Australia, despite our population only being 24 million people, and it is quite rare to find a positively geared property (i.e. one that actually makes a profit without the property going up in value). The number of negatively geared properties has also exploded since the early-mid 2000s property boom, as Mum & Dad investors reading too many money books (or watching too many renovation shows on TV) thought that they would all get a piece of the action. This explosion of investor interest, and not just from Australians (lots of wealthy Chinese investors are buying up property in our capital cities), has created expontential growth in property values, to the point where our two largest property markets (Sydney and Melbourne) rank in the top five most expensive cities in the world.

With outcomes like that it’s no wonder people are wanting this tax break reigned in!

Huh? What’s the point of this tax break anyway? It doesn’t make sense!

As you were reading the previous section above you could be forgiven for thinking “Why the hell do you get a tax break for buying a property that costs more to own than it generates? That’s ridiculous!”. And in my view, you’re exactly right – it doesn’t make any sense at all.

Well, the general rationale for allowing negative gearing is that it supposedly encourages supply of new homes, which should in turn mean that property prices remain lower, thereby improving affordability. Obviously negative gearing has had the exact opposite effect, with property prices going through the roof and the supply of new homes seriously struggling to keep up with Australia’s population growth (a result of plenty of people having babies, but also through significant immigration).

If you actually wanted to increase the supply of new homes it wouldn’t be that hard to think up a way to incentivize that, but negative gearing has stuck around unchecked for so long because there are simply too many voters in on the deal!

Negative gearing under attack – Labor’s plan

There you go - a picture of Bill Shorten with a little twitter box thing about negative gearing (although you wouldn't know just from reading the text - maybe he had to dumb it down for the nuff nuffs out there who don't know $hit about tax).

There you go – a picture of Bill Shorten with a little twitter box thing about negative gearing (although you wouldn’t know just from reading the text – maybe he had to dumb it down for the nuff nuffs out there who don’t know $hit about tax).

With the government’s finances screwed (there ain’t gonna be a budget surplus any time soon, let alone making a dent in the government’s debt which sat at ZERO in the mid 2000s) and an election later this year, negative gearing is now in the spotlight for the major policital parties.

Labor have got out in front of the game and released their plan, which is essentially:

  • If you already have a negatively geared property, we’ll let you keep it negatively geared, but if you buy an existing property you only be able to claim deductions up to the extent if the income that the property generates. Put simply: No new negative gearing for existing properties.
  • If you build a new property then we’ll let you claim your negative gearing loss.

If we didn’t already have such a huge reliance on negative gearing to support property values (e.g. if this were the year 2000 rather than the year 2016) I think that this plan would be great. It would have done a great job of restricting the property boom that we have seen over the last 15 years, and young people (even the less hardcore savers) would have a chance of buying a property in Sydney or Melbourne. The problem with the plan now though is that it has to have the effect of reducing values of existing properties, which won’t go down well with voters who are property investors. I still think that it would be worth experimenting with, but unfortunately I think Labor will get killed at the election and the policy will therefore never become real (at least in the near future anyway).

Undecided – the Liberal party’s plan

While I don’t think Labor’s plan will ever materialise (they won’t get elected), at least it’s promoting discussion of what is really a rort. And I say this as a person who has benefited from negative gearing in the past (we actually had four negatively geared properties at one time back in the mid 2000s), but perhaps it’s easy for me to say that since I’m not benefitting from it now.

The more that I have got into the whole early retirement journey I have come to realise that high house prices are a joke and don’t do anyone any good – they just force everyone to work longer to get the same things, while also reducing the quality of life for practically everyone. I actually think that a correction in house prices is long overdue, and by correction I mean “reduction”, which is something that most Australians think is not even possible (our property prices have not historically reduced in any significant way, unlike countries like the US and UK). While this would the value of our new house, I wouldn’t really care because we’re not planning on selling it any time soon (we’re not planning on moving out of there until we’re old and grey). It might mean that people can actually achieve a better quality of life, which I think is more important than having ever-increasing property values to fund everyone’s ridiculous lifestyle inflation.

As discussed above, the Labor plan is fairly clear, but the Liberal plan definitely isn’t. About all that we have to go off so far is commentary from the treasurer that seems to imply that the number of negatively geared properties allowed per taxpayer may be capped. While this option would probably avoid a significant reduction in housing values and would therefore be more palatable to the Mum & Dad investor voters out there, it’s still illogical that existing properties receive the tax break when they aren’t actually increasing the supply of housing.

We won’t find out the Liberal party’s exact stance until budget night in May, but I just can’t see them alienating a huge portion of their voters by doing anything drastic. Chances are that negative gearing will remain in largely unchanged form, but we can always hope that Malcolm Turnbull and Scott Morrison will be a bit braver on budget night…

That’s enough on Australia’s negative gearing peculiarities now, but I’d love to hear about any other similarly ludicrous tax breaks that other countries may have!

IA.

One thought on “Negative gearing – a bizarre Australian tax break that’s under attack

  1. We have a similar loophole in our tax code in the United States. Losses on operating a rental property are called “passive activity losses”. A taxpayer is able to use up to $25,000 of passive activity losses to offset other non-passive income (subject to income limitations). Any passive activity losses not allowed in the current year, carry forward to be used in future years.

    In my opinion, a rental property is a type of business. If you aren’t making money on it, you shouldn’t have to pay taxes on it. And if you are using other earned income to subsidize the rental property, you should be able to offset that income with the losses from the rental business when calculating income tax. But you’re right, it does incentivize to purchase of real estate that loses money.

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