To date, negative gearing is one of the most common ways Australians invest in properties. Tax deductions and capital gains have made the practice immensely attractive to property investors.
Its popularity has also made it one of the most talked-about practices in property investing, with many arguments raised by those for and against negative gearing. It's also a hot topic in politics, with talks about changing the current negative gearing concessions its effects on the Australian economy.
So, is negative gearing good for the economy? In this article, we’ll tackle that plus four other frequently asked questions on negative gearing.
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In a broad sense, negative gearing happens when you borrow money, invest it in something, and find the income you get from the investment is less than your total expenses. This typically occurs for property investments.
Let’s say you apply for a loan from a bank. As soon the bank grants your loan, you use the money to buy a unit in the city. As an enterprising individual, you decide to rent out your unit so you can earn a passive income. However, you find your rental income is far less than the expenses you incur to maintain the unit.
When you are negative gearing, you’re spending more on expenses as opposed to earning from rental income. If I’m spending more from negative gearing, why should I do it? Incurring more expenses instead of income on investments might sound counterproductive on the onset, but people willingly practice negative gearing on property investments for two main reasons:
When you are negative gearing your property investments, you can expect some deductions on your income tax. This is possible because according to Australian tax legislation, you are taxed based on your net income, that is, your income minus expenses.
So, whenever you incur expenses from your negative geared property, you can count it as a loss against your income. The effect? You are taxed less because you have a smaller base income.
Profiting from negative gearing your property happens much later in the game. Specifically, earning from negative gearing your property happens right when you decide to sell it.
If you invested in the right kind of property, it would likely become more valuable as time goes by. The more valuable your property becomes, the higher its sale price will be. By the time you decide to sell your property, the price is high enough to cover all your expenses as well as give you profit.
While you likely won’t find “negative gearing” written anywhere in Australian tax legislation, practising it is legal in Australia.
It is one of the most common property investment strategies in the country. Negative gearing is also a popular way for property investors to get amenable tax deductions on their income.
Here’s a list of other countries where negative gearing is also legal with some restrictions:
According to the Australian Taxation Office (ATO) of the Department of the Treasury, an estimated 1.9 million Australians earned rental income from 2012-2013. At the same time, 1.3 million Australians also reported a rental loss and claimed negative gearing benefits.
Trivia: The ATO also reported that almost 70% of Australians who received deductions on their taxes declared taxable income less than $80,000 every year.
While tax deductions and capital gain expectations are benefits of negative gearing which primarily concern individual property investors, negative gearing also has long-term effects on the economy. These long-term effects have been the subject of an ongoing debate among Australians.
To those who advocate the practice, these points are often raised to emphasise the economic benefits of negative gearing:
In contrast, these points are often raised by those who oppose negative gearing:
It seems the debate about whether negative gearing is beneficial to the Australian economy won’t end just yet. However, the Australian Labour Party seems to be anti-negative gearing as it recently chose to address the practice’s more harmful effects.
According to Labour, concessions for negative gearing property investors have been much too generous in the past. As such, the party recently proposed legislative changes to limit property investors’ tax deductions brought about by negative gearing.
In a nutshell, the new policy means property investors can no longer deduct their investment losses on newly acquired properties from their income. Labour suggests this key change strikes a balance between the positive and negative effects of negative gearing on the economy.
Once in effect, the party estimated government revenues are amounting to $2.9 billion in the first four years of its implementation. However, given that the Liberal-National coalition just secured majority of the lower house seats in the recent 2019 Australian elections, plans to revise current tax concessions for negatively geared properties might be put on hold.
The ongoing debate on whether negative gearing is good or bad for the economy is proof there much about its practice that can still be improved. Overall, capitalising on the pros while mediating its cons seems to be the best approach moving forward. This way, property investors get to enjoy the benefits of negative gearing altogether safely.
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