Negative Gearing: What The Hell Is It And Why Should I Care?

The Federal Election is looming and the Australian Labor party has made a major policy announcement – vote Labor this year and negative gearing is all but gone! The Coalition has fired back, saying negative gearing must stay!

Hear that? That’s the gaseous burp of collective indifference. Not only do I not care, I don’t think I care that I don’t care. The vast majority of Australians don’t use and probably don’t understand negative gearing, and there’s a very good reason for that – the vast majority of Australians aren’t wealthy enough to own investment property.

Give me a break

Negative gearing is a tax break for investment property owners. So by definition, negative gearing is a tax break for the (at least moderately) rich.

Moreover, it’s a tax break that has driven up property prices in Australia, putting the dream of owning a first home out of reach for a lot of young Australians. You might not benefit from negative gearing, but it still affects you. Time to get woke on this most dry of subjects.

It’s like a magic trick with money!

There is no way to make the sexless, coma-inducing mechanics of negative gearing sound interesting, so we’ll keep it brief: you buy a house, get a mortgage and rent it out.

Let’s say your annual mortgage repayments and costs to maintain the house are $50,000, and your annual rental income is $40,000. You have a net loss of $10,000, which means your investment is ‘negatively geared’ (or running at a loss). A positively geared investment property is one that brings in more dough than it costs to own.

On paper, a negatively geared property is a bad investment. But in practice? You’re a system-gaming financial boss. Firstly, according to current Australian tax laws, the $10,000 loss is deductible from your taxable income – i.e. you pay less tax. Secondly, while the government is giving you a break on your tax bill, your ‘bad investment’ property is increasing in value.

The other thing to know is that you can claim losses on any investment, but it’s only in real estate that you can claim the money against your personal income – so for some people, these losses could mean qualifying for a lower tax bracket.

You might lose a bit of money in the short term – subsidised by the government – but when you sell off the investment, which has increased in value, you cash in big time.

The myth of the mum and dad investor

In 2013, the Australian Taxation Office (ATO) reported a whopping 1.3 million Australians owned negatively geared property.

Scott Morrison, defender of the weak, insists that it is Aussie battlers who most benefit from negative gearing – teachers, nurses and defence force personnel; mum and dad investors. The Libs are relying on data from the ATO to support their claim, showing that the average income of a negatively geared property investor is $80,000.

But The Reserve Bank of Australia says the ATO stats are misleading. The stats show taxable income, which means income after negative gearing tax deductions are applied. According to the ATO stats, some people have no income at all but still own investment property. (No income, but they somehow qualified for a mortgage? Seems legit.) The ATO stats don’t include superannuation income, either, which is tax-free. (You know all those baby boomer retirees with their property portfolios? Not in the picture.) The data is hiding the real wealth of investment property owners.

According to a recent report by The Grattan Institute, middle class investors are not the main beneficiaries of negative gearing. By their calculations, the top 10% of income earners receive almost 50% of the tax benefit.

There’s no doubt that many middle income earners use negative gearing, but like most uncapped tax concessions, it’s the really well-off that reap the greatest rewards: the more money you have, the more you save.

Why does everyone keep mentioning this capital gains thing?

There are a few ways to make money in this country. You can work in a job and get paid a salary; you can run a business and make money from trading; you can squeegee car windscreens at traffic lights; or you can buy assets (a house, shares, a business) and sell them at a profit.

When you sell off an asset for a profit, the difference between what you paid for it and what you sell it for is called capital gains. You pay capital gains tax on your capital gains – it’s part of your taxable income.

Incidentally, this tax doesn’t apply to your car, your family home or your cows.

So why is this relevant? In 1999, John Howard introduced a whole new tax break for investors – a capital gains tax discount. If you buy an investment property and hold onto it for at least one year, you get a 50% discount on capital gains tax when the property is sold. So if you buy a house for $500,000 and sell it for $700,000 five years later, you’ve made a $200,000 profit, but you only pay tax on $100,000. Neat, huh?

If you’re an investor weighing up how much you’ll ‘lose’ on a negatively geared property, versus how much you’ll get when the property is sold, the level of capital gains tax you have to pay is a pretty significant factor. The 50% discount, alongside negative gearing, has been a great incentive for people with spare dough to invest in the Australian real estate market.

The current state of play

Negative gearing in Australia is like gun control in the US – an historically untouchable subject that is now no longer taboo to discuss openly.

Labor has recently announced that they want to abolish negative gearing on existing property and cut the capital gains tax discount to 25%. They’re projecting billions of dollars a year in additional tax revenue as a result, which has been verified by independent modelling. But, they want to leave negative gearing tax concessions in place for newly built houses, a policy Labor says will increase the housing supply in Australia, meaning more people can afford to buy their first home.

The Liberal Party thinks Labor’s policy is a dud move. Cut the incentives to invest in property and one out of three potential buyers will leave the market; property prices will crash. Investment property owners who can no longer deduct their net losses from their taxable income will increase rent to cover the difference, and humanity as we know it will explode in a fiery ball of chaos.

So what does this mean for you?

According to the Australia Institute, Australians under 30 get less than 7% of the tax benefits from negative gearing, capital gains tax discounts and superannuation tax benefits. There are some entrepreneurial/advantaged young people who have found their way into the investment property market, but they’re the exception to the rule: these are tax breaks that almost exclusively benefit older investors.

It’s these older investors that you’re bidding against when you go to buy your first home.

Australia is in the midst of a housing affordability crisis. The average house price in Australia is $650,000 and it keeps creeping up. According to Ram’s home loan calculator, you have to earn approximately $100,000 a year to afford a mortgage on a $650,000 property. According to ABS statistics, the average salary for Australians under 30 is around $40,000 a year. It’s not, as they say, a level playing field, and young people are on the losing side.

There’s talk that making changes to negative gearing could destabilise the Australian property market. It could, but is unlikely to drive up rent. But it could also mean that young and disadvantaged Australians can finally catch a break, that they can do what their parents did relatively easily – buy their first home. Investors have had it good for a good long while. Maybe it’s your turn.

Ok, we’re done. Enjoy this video of a tiny hamster eating a tiny burrito. You’ve earned it.

Simone Ubaldi is a ghostwriter, music journalist, film critic and has co-authored four books, including memoirs of Bon Scott and Mark ‘Chopper’ Read.

Lead image: Wikipedia