Negative Gearing and the CGT Discount are Topics of Heated Discussion in the Lead Up to the Election
How does negative gearing work, what are the risks and, if Labor gets in, what might their proposed changes to negative gearing mean to investors?
Put simply, negative gearing allows property investors to offset rental losses against their personal taxable income. These rental losses generally occur because the cost of owning a rental property outweighs the income it generates. Rental losses include almost everything associated with owning the property, including interest incurred on the home loan, maintenance, and other expenses, such as lawn and garden upkeep costs.
In addition to property, negative gearing also applies to businesses and shares, but because the high cost of housing in Australia (let’s not forget that the median national house price just reached $1 million) is locking a lot of young people out of the property market, negative gearing has become a popular topic of discussion among economists, property observers and politicians.
How Does Negative Gearing Work?
Say a person owns a rental property which generates $50,000 a year in rent, but the cost of holding the property — this includes interest on the mortgage — comes to $55,000 a year. The owner has a taxable loss of $5,000, which they can use to reduce the tax payable on their salary. Property investors are also entitled to a capital gains discount of 50 percent once the property is sold.
In effect, negative gearing (and the CGT discount) enables property investors to rent property without wearing any of the costs, and when the value of the property increases (currently at a rate of 2 percent per quarter), they’re able to make a sizeable profit off the sale of the property, thanks to the CGT discount.
If an investor knows in advance that their investment will record a loss, they can also apply to the ATO to reduce the amount of tax taken out of their salary, which is called PAYG Withholding Variation, and significantly improves their cash flow.
Economists have long speculated that, given most investment property loans are obtained using the equity of an existing property, negative gearing is the reason investors can afford to pay more for investment properties, effectively pricing young people or many owner-occupier buyers out of the market. And this is precisely why the Labor party is looking at negative gearing and the CGT discount as it relates to housing.
There are Still Risks Associated with Negative Gearing
As with any investment, there are, of course, risks associated with negative gearing. When you negatively gear a property, you’re still recording a loss. There can be many pitfalls associated with negatively gearing an investment property, particularly if the property is located outside of an area with plenty of amenities, where the demand for housing is lower.
Some of the risks associated with negative gearing include:
- the property sits empty for long periods without tenants
- there could be a dramatic downturn in property values and the investment fails to increase in value
- interest rates rise very quickly, but the tenants have a fixed-term lease.
Stay Tuned for a Negatively Geared Election
Given the Labor party’s sudden interest in how negative gearing has affected property prices, negative gearing and the CGT discount is going to play a key role in the upcoming election. Already the Labor party has proposed changes to negative gearing and CGT, which the Coalition says would reduce the number of buyers by 30 percent. The Prime Minister, Malcolm Turnbull, says this is likely to have a meaningful impact on the property market.
— This article was first published at Selling Your PropertyDo you like what you've read? Subscribe for free to receive my blog posts in your email inbox. While you are at it you can tick the box and get access to all my real estate training videos.