Negative Gearing Explained
What exactly is negative gearing, why was it introduced in the first place and why is it such a political hot potato? Well, let’s start from the beginning.
Negative gearing was introduced in the early 1980s as an incentive to encourage Australians to invest in property. The incentive lay in the benefit of offsetting the tax payable on your income by the expenses incurred from owning an investment property.
Expressed at its simplest, it’s borrowing money to make a tax loss.
The central theme of the current debate about negative gearing is housing affordability. Labor believes that abolishing negative gearing will drive down house prices because fewer investors will compete with purchasers on auction day, therefore making the Great Australian Dream of owning your own home more attainable, and particularly for first-time buyers. Liberal, on the other hand, believes if you abolish the scheme it will drive up rents because there will be fewer available rental properties as investors will leave the market in favour of other investments.
So who is right?
It seems the confusion or debate stems from the mid-1980s when our Prime Minister at the time Bob Hawke and his Labor cabinet made the decision to abolish negative gearing.
The net result was a surge in rental yields. However, upon deeper research, this was only the case in Sydney and Perth. In fact, the balance of the country’s property market remained unaffected by the change. What actually attributed to the rise was a combination of economic growth, population growth and a shortage in new housing. The scheme was reintroduced two years later.
In 1960 a house cost 1.6 times the household income. In 1985 (the year negative gearing was introduced) it increased to 2.25 times the household income. But in 1999, when John Howard introduced a capital gains tax discount, it significantly increased investor activity in housing. Fast forward to 2016, and bearing in mind that most homes today are double-income households, a house will cost 4.3 times the household income.
So what does this mean?
Clearly the more incentives investors have, the more likely they are to sit at the table and play their hand. Leaving the debate at the political door for a moment, let’s consider why you would negative gear in the first place – to offset tax. It can’t be more simply explained than that.
Who can do it? Anyone.
There is a misperception that it is a strategy only for the wealthy. It’s utterly incorrect. If you want to reduce your tax payable on your income and have the ability to save a deposit, service a loan and cover the gap between the cost of your asset and the income generated from the property, you can negative gear. Like all investment decisions, it’s a personal choice dependant on one’s personal set of circumstances.
However, in all of this discussion it’s wise to remember that while the government introduced the scheme for Australian investors, the underlying purpose was to generate more income for the government. Negative gearing has contributed billions of dollars since its introduction. This would create a gaping hole in the government’s purse if it abolished negative gearing.
It’s interesting that the Opposition wants negative gearing cut to focus spending on health and education. I’m not sure standing at the traffic lights rattling a tin can will be quite as substantial.
So what have we learnt?
Nothing really other than the government is doing what they usually do and creating hype for its agenda. Either way, investing in property is a wise long-term strategy. As long as there’s money in it for the government, I don’t think we’ll be seeing any drastic changes to negative gearing.
Words: Bryce Deledio