What about negative gearing?

What about negative gearing?

What about negative gearing?

What the market perceives is that housing prices are rising due to property investors buying stock due to the many negative gearing tax benefits which in turn is limiting the first home buyer choices. It would not be rocket science though to guess what would happen if these tax benefits were removed.

No doubt some investors would leave the property market. Prices on houses might ease somewhat which would be a benefit to some people trying to buy their first home. However, a reduction in the amount of investment properties would most certainly see a rise in the weekly rents for 2 reasons; shortage of supply and investors trying to recoup money on their investments. 

This flow on would affect the most vulnerable in the community with a rise in the cost of living which the government would most certainly want to avoid.

One other aspect to remember is that to stop negative gearing on one asset class investment is dangerous territory and would create a bias and a distortion in the market. Investors might choose to borrow money and buy a share portfolio which is negatively geared or a business and offset losses against other income. This resultant bias could have unknown consequences. 

In 1985-87, the then Hawke/Keating government quarantined negative gearing. As a result, rents rose throughout the country and the experiment was abolished and negative gearing reinstated.However, if one looks closely at the tax act and how it applies to negative gearing it could be said that there is nothing that needs to be amended; only laws that need to be enforced. I borrow the following 3 paragraphs from an article by John Edwards, head of Residex which researches the property market.   

"Notwithstanding all of the above, what one cannot do is enter a transaction with the main purpose of reducing your tax liability. To do this would be contrary to the provision of Part IV A of the Tax Act (anti avoidance provisions). Equally, if you are entering the transaction on the basis that you will make profits from capital gains only, and not from rental cash, then you are trading in property. Property traders are not entitled to the capital gains tax benefits. Clearly, when you look at the current position in terms of this, it will be clear to most that there are many transactions that should be challenged by the Commissioner of Taxation, and significant deductions not allowed.

Perhaps the problem here simply is the fact that the Tax Act is not being enforced strictly enough. Obvious excessive gearing, which on any reasonable modelling indicates that a party could not make loan repayments without the tax loss, should be challenged. The exception to this is if it can be shown reasonably that the investor is expecting that the property will, during their anticipated holding period, produce rental returns that will cause the property to produce annual, taxable profits. A simple statement by the Tax Commissioner that transactions which are geared in excess of a specified level, and produce tax losses annually, will be challenged under Part IV A, would solve the problem.

To this extent, the Tax office might issue guidelines to allow people to understand when they are potentially overstepping the mark. At this point it is worth recognising the fact that it is not the Tax office’s fault that there has not been stricter management of residential property investment. It is more an issue for the Federal Treasury. The Tax Office is the instrument of the Federal Treasury, and the Tax Office acts in terms of their direction. Equally, it has to have the required staff to implement rules and regulations."