One of the most common subjects I am asked about as an accountant in public practice is Negative Gearing. Over time the expression has become a term connected to smart investing. Recently politicians have made it sound the scourge of the economy and a tax scam used by wealthy tax dodgers. So what does it mean and what should we do?.
“Negative” is just the term used to describe an investment, typically a rental property that loses money. “Gearing” is the term used to describe borrowing money to increase the amount invested. Our tax system adds together all of our income and we pay tax on the net result. So “Negative Gearing” is not a dodgy tax scam, it is using borrowed money to invest in assets that don’t always make a profit. A property is negative Geared if the rent is less than all the expenses including rates, repairs, management fees and bank interest.
If a property is negative geared, the tax saving will reduce the loss. This makes the investment less negative. “Positive Gearing” is the opposite of negative gearing. It’s better if you can buy a property and make money from the rent, as well as still profit from its sale.
So what are the politicians up to? Painting negative gearing as the evil cause of the budget problems, may make it easier for voters to swallow change, but what is really wrong here and what will the affect be if the law is changed?
With the introduction of GST, income tax rates were lowered as a part of the revenue plan. Over time, inflation has caused average incomes to move into higher tax brackets. This effect is called “Bracket Creep” and caused by wages increasing faster than the government increases the tax brackets. Taxpayers are again paying very high tax rates with the top tax rate being 49%. Basically half! But the capital gains tax rate was reduced by making 50% of any profit from asset sales, tax free. This has reduced the tax revenue from Capital Gains tax as the maximum rate is now effectively 24.5%.
Changing negative gearing is not fixing the cause of the problem and may in fact result in less revenue. There is strong argument that capping negative gearing will stop investment, cause property losses, and will affect the economy. In 1985 the Hawk government capped negative gearing. Losses from investments could not be claimed and there was no tax benefit. This proved very unpopular and the government reinstated negative gearing just 2 years later. There were so many factors affecting the economy at the time that there was no clear cause and effect other than the fact that it was unpopular. If you can remember back then, interest rates were as high as 18%. The then treasurer was attempting to bring down interest rates by discouraging borrowing. Interest rates now however, are at record lows.
As an investor in property, like most of us, I don’t want a change to either the capital gains tax rates or the scrapping of negative gearing. But the government has to manage the economy and reign in the budget deficit. As a defense against change I believe the best strategy is to look for positive geared investments. Fortunately Mandurah offers a reasonable number of properties that with a small deposit are close to break even.