Why negative gearing should not be abolished

Once again the value of negative gearing to allow property investors to buy their properties has come into question.

Some academic commentators and social welfare lobbyists seem to regard negative gearing as primarily a tax avoidance device use by the wealthy to rort the system, which has the added consequence of pushing up property values.

Negative gearing is not just for the rich

The assertion that all negatively geared property investors are “ugly, wealthy Australians” is simply unfounded and incorrect.

According to 2006-07 ATO taxation records, 1.6 million taxpayers claimed rental income, and of those, two in three negatively geared their investment(s). Interestingly, these investors predominately do not come from the wealthy end of town. Indeed, 74% of negatively geared investors earned less than $80,000. Only 4% were in the top tax bracket.

The fact is that using the benefit of negative gearing investment has allowed many ordinary working-class Australians to invest in property and to take control of their financial destiny.

Property investors provide an essential service

While some opponents of negative gearing appeal to the frustration of would-be home owners, suggesting they have been locked out of the market by greedy, tax-driven property investors who receive billions of dollars of tax breaks that push up property prices, I would argue that property investors provide an essential service to millions of Australians who chose to, or have to, rent their accommodation, and as such these investors should be treated like all other businesspeople.

In our modern society we pay taxes and expect the government to provide us with certain essential services. These include hospitals, roads, schools, jails, public transport, aged care and public housing.

In Australia, the government often shares the burden of providing these services with private enterprises that can often deliver them more efficiently and cheaper.

When the government can’t supply enough public hospital beds, privately run hospitals step up to the mark and not only receive tax deductions for their business loans, but also allowances to subsidise them. So do aged care providers, schools and public transport providers that provide services in tandem with the government.

Our government also provides public housing, but not enough for all those who can’t afford to buy their own property.

While government programs such as the National Rental Affordability Scheme and other social and public housing programs are helpful, it is only the private rental market that can deliver rental accommodation at the rate and scale that is required at present.

Property investors save a deposit, buy a property, commit to a loan for 25 or 30 years and provide accommodation for others in our community. In return we expect to get a reasonable return on our investment risk, just like other businesspeople do.

We know that the rent won’t cover our expenses, but accept that certain tax benefits plus the long-term capital growth will make up for this.

Sometimes it does, and sometimes it doesn’t.

What if the government removes negative gearing?

Leverage and negative gearing compounds returns in the good times, but multiplies losses when property prices are flat or falling. I know as many people who have lost money in property investment as those who have made money.

Much like most other small businesspeople.

If the government takes away my tax concessions, I would have to consider my investment options. To ensure I get a decent return I’d put up my rents if I could, or maybe I’d invest elsewhere to get the best bang for my bucks.

The result would be that rents would rise and tenants would have to fight over the few rental properties left, or the government would have to invest its own money and buy or build properties and enjoy the pleasures of being a landlord.

Of course the government already provides some public housing, but not enough, leaving the task of providing rental accommodation not only in our capital cities, but also in regional Australia and in the remote mining towns to private investors. People like you and me who have chosen to run our own little property investment businesses.

If I set up a dog wash business or a restaurant, I’d be able to claim a tax deduction for legitimate business expenses including loans to set up our business or purchasing business equipment.

Why should it be different for property investors who take on a business risk?

Doesn’t negative gearing push up property values?

To say negative gearing has pushed up property prices is a smoke screen.

Just look what happened to property prices overseas in countries like the USA and parts of Europe, where negative gearing isn’t allowed. They experienced a boom and a subsequent bust of much greater magnitude that we have.

What these lobbyists may not recognise is that borrowing in order to undertake productive investment actually helps economic growth because value is being added.

After all, there will always be some investments that have lower returns than the interest expenses on the loans taken on to acquire them. This economic reality has nothing whatsoever to do with tax.

For example, a typical property investment may start off with a large loan and lowish rent. As time goes by the loan is paid down and the rent increases. Overall, the investor makes a profit and the tax office gets its share of this.

Actually, there is not as much loss of revenue to the authorities as some critics believe, because for every dollar of interest claimed as a tax deduction by a borrower there is a corresponding dollar of interest assessable to a lender.

But that’s not all

If the government stops the availability of negative gearing benefits, the danger arises that there may be unintended consequences.

It is possible that even following a positive cashflow strategy you end up negatively geared and suffer. What if:

• Interest rates rise after you buy your investment?
• Rents fall or your property becomes vacant for a period of time? or
• You have to undertake a major repair of your investment property?

To deny the person making a commercial loss like this a tax deduction would be to inflict a double whammy on them and increase their hardship unduly.

In conclusion

Any reduction in negative gearing benefits would significantly reduce rental investment in both new and existing properties and would worsen rental affordability through a reduced supply of investment housing. A reduced rental supply means lower rental vacancies and increased rents.

Property investment is a real and effective method for bolstering the savings of middle Australia at the same time providing accommodation for those who the government can’t or won’t help and should remain as is.

Michael Yardney is a director of Metropole Property Strategists who create wealth for their clients through independent, unbiased property advice and advocacy. He is best-selling author, one of Australia’s leading experts in wealth creation through property and writes the Property Investment Update blog. Subscribe today and you’ll receive a free video training – The Golden Rules of Property Investment.