With the Federal Election only months away, negative gearing remains front and centre as a major point of debate and contention between Australia’s two major political parties.
Bill Shorten’s Labor Government has promised to overhaul negative gearing rules for investment properties should they win the election. The current Liberal government stands firmly opposed to the stance. So, what are Labor’s proposed changes, and how could they impact property investors?
Negative gearing: explained
Gearing is a term that tends to be used primarily in relation to property investment. The income you earn from your investment is usually either positively or negatively geared.
A positively geared property is one where your incomings i.e. rental return is higher than your outgoings i.e. interest repayments, repairs, strata fees etc.
An investment property is negatively geared when the incomings are less than your outgoings. The shortfall can be claimed as a loss when you do your tax return – essentially to reduce your taxable income and therefore tax payable.
Many investors use negative gearing to reduce their taxable income over the short term – as the loss can be deducted from other earnings. These investors are typically targeting long term capital growth above their accumulated losses for when the property is ultimately sold.
As a simplistic example of negative gearing: John Smith earns a salary of $70,000 a year. Out of which, he would pay $15,167 in tax.
If he purchases a $650,000 investment property, with a rental income of $650/week and outgoings of $750/week, then he has a weekly out of pocket expense of $100/week. If John claims this as a loss, he reduces his taxable income to $64,800 ($70,000 – $5,200). This makes John’s tax payable $13,345, a saving of $1,822, which reduces his weekly out-of-pocket expense to $65/week.
If John’s property has depreciation claimable as well, then this would be counted as an ‘outgoing’ – even though it’s not an actual ‘out-of-pocket’ expense. This would increase John’s shortfall, which would in turn further reduce John’s taxable income.
For example, John’s brand new $650,000 unit has annual out-of-pocket expenses of $5,200/year. His first full year depreciation claim is $13,832. Therefore, John’s total ‘shortfall’ in his first year is $19,032, making his taxable income $50,968. This would reduce John’s tax payable to only $8,366 – a saving of $6,801 – or roughly $130/week – therefore putting John $30/week ahead overall.
What are the proposed changes to negative gearing?
If elected, the Labor party has plans to limit negative gearing to new residential properties only. The plans will take effect from a date that is yet to be determined after the next Federal Election, which is likely to fall in May.
They also propose to halve the capital gains discount for all properties purchased after a date (also yet-to-be-determined) after the next election. In effect, this will reduce the capital gains tax discount for properties that are held longer than 12 months from 50% to 25%. If you sell your investment property in less than 12 months you’ll pay the full capital gain tax – this is what is currently in place.
All changes will be grandfathered, which means they won’t apply to any properties purchased before Labor puts its changes into effect.
The policy has been proposed to tackle housing affordability, while also boosting construction to keep up with Australia’s strong population growth. Critics of negative gearing reform suggest it may have the opposite effect or be a repeat of 1985, when Bob Hawke’s Labor government entirely abolished negative gearing only to reintroduce it 18 months later.
What’s really going to change?
According to a poll by The Australian, in April 2017 54% of respondents supported negative gearing reforms. By November 2018, this figure had fallen to 47%.
Public opinion on the issue continues to be mixed to the point where the Labor Party recently indicated that a negative gearing re-think is possible. Earlier this month, Mr Shorten confirmed that proposed timings for the reforms will be deferred till after an election win.
If the reforms do go through, for investors of new property, changes to negative gearing will not apply, and for long-term investors who are holding properties for retirement or later in life, the capital gains tax change will also have no immediate application.
Regardless of whether these reforms go through or not – or whether or not Labor wins the Federal Election – it’s important to note that investors still make up only a small minority of the Australian taxpayers, only 8.69% according to the latest data available from the ATO and they also play a valuable role in providing rental properties to the market for those that can’t afford to buy, or simply prefer to rent.
At Ironfish, we recommend a buy-and-hold strategy and to ensure your investment properties represent quality, with strong owner occupier appeal. You want to ensure your property appeals to the widest possible market when it comes time to sell – and as the above data shows, owner-occupiers are the majority by a significant margin. Owner-occupiers may also be more willing to pay a premium for something they fall in love with, compared to an investor.
“If Labor gets elected this year and upholds their promised changes to negative gearing – which will favour new property – then owner-occupier appeal will be even more important for investors when and if they decide to sell,” said Ironfish CEO & Founder, Joseph Chou.
“We have seen from experience that short term market fluctuations, or policy changes will always come and go. The key is to ensure you are investing in quality properties in good locations and prepared to hold over the long-term,” Mr Chou added.
Ironfish property investment resources
- Did you know that Ironfish has custom portfolio analysis software and tools which can help you to visualise and quickly calculate different cashflow scenarios for your investment property? Just book in a free appointment with one of our Strategists to take advantage of this and our other great investor resources.
- We hope this blog has given you a better understanding of the general concept of negative gearing. But if you would like more information about negatively geared property investments or other financial matters, please seek advice from your qualified finance professional. We are happy to provide some recommendations of finance professionals if you need – just drop us a line.