Negative gearing: the facts for property investors

Source:  BMT Insider, Brad Beer, BMT Tax Depreciation

Over the past few months most of you would have read or heard about negative gearing in the media. There has been heated discussion both in favour and against current negative gearing policy, as well as examination of the potential risks and benefits for investors.

Although we would prefer to remain apolitical, we at BMT are concerned about the current proposals to make changes to property tax concessions and the potential impact on our clients.

We are therefore including some information to help you to understand the impact of the different policies.

What is negative gearing?

As you know, when you invest in a property, the cash flow position will depend on the income earned and outgoing expenses such as interest repayments, council rates, insurance, property management fees, repairs and maintenance or other miscellaneous costs.

In a situation where an investor is receiving a higher rental return than the outgoing expenses, the property will have positive cash flow and the owner will pay tax on this income earned at their top marginal tax rate.

By contrast, a negatively geared property has a rental income which is less than the outgoing expenses including deductible losses. Therefore the property investor is making a cash loss on their investment.  

Currently, income producing property owners are entitled to offset these losses against other income earned, including their wage or salary.

By offsetting these losses, investors reduce their taxable income and will reduce the amount of tax they need to pay as partial compensation for making these losses.

The ability to claim the losses that are over and above the income generated against wage or salary income is only allowable because of negative gearing legislation.

Any proposed restrictions on negative gearing will be reducing a property investor's ability to claim a tax deduction for these losses.

Recent data from the Australian Taxation Office (ATO) released for the 2013-2014 financial year shows that of the 2,842,139 Australians who receive a rental income for their properties, 1,691,355 do so at a loss. This means that 59 per cent of Australians who own investment properties are negatively geared.

Policy matters

Each of the parties have outlined their position in regards to negative gearing in the lead up to the 2nd of July 2016 federal election. Below is a summary:

• Labor plan to restrict negative gearing tax concessions from July 2017, next year. Negative gearing will no longer be available on any second hand properties purchased. At this stage, no changes are planned for investors who purchase brand new properties.Capital Gains Tax (CGT) exemptions will also be changed under Labor. Currently, individuals or small business owners who hold an income producing property or other asset for more than twelve months receive a 50 per cent discount from CGT. The change proposed by Labor will mean that investors will only be able to claim a 25 per cent CGT discount from July 2017. An incoming Labor Government will be in a position to enact their policy as they are very likely to have the support of the Greens in the Senate
• The Greens plan to get rid of negative gearing tax concessions altogether. They also plan to reduce CGT discounts by 10 per cent each year from the 1st of July 2016. From the 1st of July 2020 there will be no CGT discount at all. The Greens are likely to seek support for their more restrictive policy from an incoming Labor Government as part of negotiations in the Senate
• The Coalition has advised they will not be making any changes to current negative gearing concessions or to CGT exemptions. Negative gearing and CGT exemptions will remain in its current form under a returned Liberal/National Government.

The risks

Should the current Labor or Greens proposal be enacted, commentators predict that property prices will fall as a natural consequence of property investors largely deserting the marketplace. This is a real concern for all property owners.

Predictions vary from between 2 per cent price fall (Grattan Institute) to up to 30 per cent fall (Bill Moss). Obviously price declines will vary by geographical area and will be largely determined by the balance between supply and demand.

Education and proper understanding is key. We encourage you to review the policies in more detail and make an educated decision on polling day.

Should you have other questions, we'd be happy to help as best we can.