Will Investors Soon Lose the Negative Gearing and CGT Benefits?
Treasurer Joe Hockey recently introduced the government’s discussion paper on tax reform. He called it,“The start of a conversation about how we bring a tax system built before the 1950s into the new century.”
The white paper’s primary objective is to make a case for the need to increase the goods and services tax (GST) rate and introduce a series of cuts in income and company tax.
One of the Treasurer’s key arguments is that of the 33 developed nations that have taxes similar to our GST, only three charge less than Australia. The average GST rate is just below 20 percent, nearly double what Australia is charging.
But the Treasurer also said every aspect of the tax system is up for review, not the least of which is negative gearing and the capital gains tax (CGT) concession.
Just in case you’re new to the world of Australian property, I’ll offer a quick explanation. The negative gearing tax benefit allows Australians to write off the losses made from rental properties against their income tax. The CGT concession refers to a discount of 50 percent for individuals and trusts that hold a particular asset for at least 12 months.
The impact of these two tax benefits on Aussie property prices cannot be over-emphasised. When they reintroduced negative gearing in 1987, and when the CGT discount was initiated in 1999, in both instances, property values soared permanently beyond the previous highs. Both of these tax laws have remained significant drivers of investor demand and speculation, and therefore for property values, too.
So What’s The Big Deal?
The problem is that when the government tinkers with the economy through monetary and fiscal policy, such as interest rate changes and creative tax laws, the impact can be undesirable.
For example, the Reserve Bank of Australia (RBA) currently finds itself in quite a conundrum. As is clear from their statement last week, they are compelled to lower interest rates again to devalue the Australian dollar to boost growth in demand of our exports, to increase consumer spending, and to lift inflation. But there will be a cost.
Sydney and Melbourne property prices are soaring. Since the RBA cut official interest rates to 2.25 percent in February, Sydney’s auction clearance rates have been in excess of 80 per cent. Melbourne hasn’t been far behind. Another interest rate cut will almost certainly have a further inflationary effect on these housing markets.
How can the Reserve Bank achieve their goal without fueling the already-expanding property bubble? One option is to call on the help of the government to make adjustments in fiscal policy; in other words, to reform the tax code.
Does this mean the winds of change are blowing? While the likelihood is low that they will scrap the negative gearing benefit altogether, there are other scenarios that could significantly impact the Aussie property investor.
Here are three potential outcomes of the current tax reform debate:
1. Introducing An Income Cap To The Negative Gearing Benefit
The original purpose of the negative gearing benefit was to boost the housing supply by encouraging greater investment into housing construction, and therefore employment.
The intended goal was not to encourage speculation, reduce home ownership and redistribute wealth towards the already-affluent.
Opponents of negative gearing point to the exponential growth in tax deductions over the past 15 years.
Negative gearing reduced personal income tax revenue in Australia by $600 million in the 2001/2002 tax year, by $3.9 billion in 2004/2005, and $13.2 billion in 2010/2011.
In response, Aussie Home Loans founder, John Symond,suggests we scrap negative gearing for investors in the luxury home market. In an interview with The Australian, he said,
“The intention of negative gearing when it was introduced was not to facilitate a $10 million to $20 million house to rent out, get a 2 percent yield and write the rest off on negative gearing…It needs tweaking on capping the benefits.”
While this change would have little impact on stifling the speculation of mum and pop investors, it would prevent the unintended consequence of rewarding the wealthy.
2. Limiting The Negative Gearing Benefit To New Dwellings
All other things being equal, the Australian property market has a fundamentally strong basis: Demand is increasing amidst a shortage of supply. The negative gearing benefit was originally intended to address this supply issue.
But, the current law allows for the negative gearing benefit on the purchase of existing housing, which does not directly encourage new construction. To address this, the government could limit the benefit to new dwellings.
Louis Christopher, managing director of SQM Research, likes the idea.
“By allowing negative gearing on new residential properties and off-the-plan developments, we are providing a proper tax benefit where it is justified and needed most: The construction and development of new dwellings.”
Bank of America Merrill Lynch chief economist, Saul Eslake, has been another vocal critic of negative gearing for existing dwellings, arguing it does nothing to boost supply.
3. Removing The CGT Concession For Property Investors
In the government’s recent discussion paper, the Treasurer doesn’t directly blame negative gearing for inflating property prices. Instead, he calls into question the bigger tax picture that makes negative gearing profitable.
Since late 1999, the capital gains tax has applied to only half of the profit made when each rental property is sold. The white paper claims it is this arrangement, rather than negative gearing itself, that is driving investment in rental properties.
One outcome of the tax debate could be to completely scrap the CGT discount for property investors. This would no doubt put a significant damper on investor demand and counteract the current low interest rate environment.
Saul Eslake,an economist, has addressed this issue for years, as well. In an interview in 2013, he said, “I can see no compelling economic reason why income from capital gains – that is, income from speculating – should be taxed at half the rate of income from working.”
Of course, implementing any of these changes could be rather tricky. What would you do if you knew that in six months, the negative gearing benefit or CGT concession would become a thing of the past?
That said, investors currently holding properties would likely be unaffected. The changes would almost certainly apply to all properties purchased after a particular date. Perhaps we would see a mad rush into property to be grandfathered into the old tax code, followed by a significant drop in investor demand after the change takes effect.
What Are Your Thoughts?
So what’s you’re opinion? Are the winds of change blowing? Is negative gearing and the CGT concession good or bad for the Australian economy? Will the government have the courage to make such dramatic changes to the tax code? Take a moment to leave your thoughts below.
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Not according to Abbott when interviewed on the issue last week…..
This being said….as long as they are going to do the same rules for ALL investing then doesn’t bother me in the slightest.
So basically merchant banks can no longer write off interest for their margin loans to buy shares (a house and a share is the same as far as I’m concerned).
At the end of the day cheaper properties will just allow me to drive up my rental ROI and buy more IP properties.
I somehow think its going to screw up the economy and share trading/business deductions more than it will bother me……so my answer to Abbott/Hockey is go ahead….do ya feel lucky punk….well do ya?
Re thought #1 :-
“The original purpose of the negative gearing benefit was to boost the housing supply by encouraging greater investment into housing construction, and therefore employment.”
A noble and useful thought indeed – with housing being such a necessary part of our economy as well as our lifestyle, the initial thought behind the law made sense to me. But, those “unintended consequences” are lurking whenever a Govt makes any Law change – thus requiring further changes to get rid of the bad outcomes (loopholes) that were not part of the original intent.
I agree that a $10m property does not need to be subsidised via “Tax relief” – those with the wherewithall to purchase these also have the wherewithall to cover “expense ups-and-downs” without Govt (taxpayer) help.
I am in favour of looking at a “cap on value” re negative gearing.
Re thought #2.
“The current law allows for the negative gearing benefit on the purchase of existing housing, which does not directly encourage new construction. To address this, the government could limit the benefit to new dwellings.”
I am not so sure about this one – as in the mid-80’s, fiddling with the negative gearing laws saw investors bail in huge numbers, and rents screamed upward.
The negative gearing option gives “Mums and Dads” a go at investing in property. Also, the whole rent vs buy situation has its own curve, and the (nonsensical) comments about investors preventing young home buyers from purchasing by buying up all of the stock is a furphy. Here’s why :-
1. How many investors want to “overpay” for IP’s? A potential home-owner (if financially capable) can out-bid any investor any day of the week. If they are not financially capable, why are they trying to buy in THAT market?
2. While it remains cheaper to rent than to buy, a home-buyer really needs to search for reasons to purchase. Why not rent – and buy an IP?
3. Many first homebuyers are wanting the top quality home first up. Didn’t we all have to “buy what we could afford” until the equity lift in our first purchase allowed us to find a bigger deposit for something better/bigger (along with a wage rise or three)?
Thought #3 – Capital Gains
It is interestng how the “old way” is seldom mentioned. In 1999, the introduction of the CGT law to allow a “50% discount if held greater than 12 months” was to replace the OLD WAY….
…and that was Indexation.
As we all know (Govt’s too) inflation reduces the value of today’s dollar when compared with yesterdays. The Govt had an Indexation figure that was ccalculated yearly, allowing us to apply a “discount on $$ gained” if selling a property that we had held a number of years.
Any gains we made were reduced somewhat according to the Index. Also, any gain we made in the year we sold had Tax calculated in a much kinder way – something like “Take your gain, divide it by 5 to get 20%, find your marginal Tax rate based on that 20% gain, then pay your Tax on the full 100%, but at the possibly lower Marginal Rate”.
When the law changed, it appeared that the “50% discount” method was pretty close in result to “the OLD WAY”. So, no real gain for the investor there. Why push to grab 100% now? It would lead to the same “Investors rush for the door, and rents sky-rocket” situation that the first point discussed. And with “bracket creep” being ignored by Govts for some years, this would be rather hard on some investors, depending…..
Watch out if this law changes – and, if it does, it would SURELY have to be non-retrospective if revolution is to be avoided !!! :p
If landlords were to be hugely affected by any proposed tinkering, look for rapid rent rises, and perhaps a temporary slump in values – not that investors push prices upward, but that suddenly there would be a heap of IP’s on the market that weren’t there last week!!
Once the supply/demand curve stabilises within its new parameters, I would think house prices would resume their steady tick upward.
Benny
Absolutely agree with Benny’s comments, especially the response to Thought #2 and point #2 in particular: The problem I have with whole affordability issue with first home buyers is that they want their DREAM home STRAIGHAWAY !!! – we started in a two bedroom unit in an outer suburb, worked our butts off for several years and saved our money before even thinking of moving postcode and upgrading dwelling.
I was brought with the saying “cut your coat according to your cloth”…. Something the generation of today has absolutely no concept of, maybe owing to the ease of accessing credit in today’s market !!!
Great point Keith. I was talking to a builder last week who sold a home to FHBs in their early 20s. Their build cost was $420k. Would we call that “cutting your coat according to your parents cloth”?
They will never take away negative gearing unless there is a complete economic collapse
Every decision is made to increase lending (ie the money supply). Debt = money. Lower debt = less money = less tax revenue.
There will be no change to anything that detrimentally effects property values as a huge proportion of lending is lent against those values.
Good point. I wonder how much properties would be worth if government and the RBA took their hands off.
As the owner of investment properties in regional Queensland I cannot emphasis enough how much I rely on the tax refund to fund exhorbant council rates and property maintenance issues on existing properties. I did not enter the market to make quick money but rather to extend to people affordable housing. Unfortunately, with the Queensland governments shutdown of jobs and support to the regional centers which has left me without tenants I would not be able to survive. Negative gearing, if used to encourage mum and dad investors into the market to help their retirement I personally think has major benefits but as with anything it is subject to exploitation by the already affulent and their flashy accoutants.
I think they should bring back the old CGT method introduced in 1985. Two things made it fairer, and so more acceptable, than the current system. The first was that the inflation component was first deducted when calculating CG and then the gain was spread over 5 years so as not to tax it all at the top tax rate.
How is it fair to give a 50% deduction for someone who has held a property for 20-30 years and the same deduction after 12 months.
Good point Elizabeth.
Property prices in Australia are ridiculous. Benny says we should start at the bottom and buy what we can afford. Here in Port Macquarie, a basic 3 bedroom house on a 300-600sqm block is around $370-450K. For a small family, that means $370K is the bottom. House prices have risen $45K in the last two years, so for most young families, they can’t save as fast as prices are going up.
Scrapping negative gearing and the CGT discount would certainly cause prices to correct. I would be in favour of a phase out of both over a five-year period, with a 20% reduction per year. This would give investors time to formulate an exit strategy. With rental yields increasing over that five year period, perhaps some investments become neutral or positively geared and investors don’t need to dump them.
Going forward, perhaps negative gearing could apply only to properties purchased new, and only for five years, with a 20% reduction per year.
Indexation seems like a fairer system than a flat 50% CGT discount from day 366 on. Maybe the CGT discount could be 10% for each year that the asset was held, up to a maximum of 50% if held for five years or more.
If negative gearing was truly intended to boost supply, it would make sense to only allow it for new dwellings moving forward. Interesting idea on the phase out.
If my memory serves me correct, wasn’t income tax introduced for a limited time to pay for World War 1 expenses and then was to be extinguished. However, as governments have become drunk on spending our money on their lifestyle and egos. it would be nice if we actually got value for the exorbitant taxes we pay. Wwhne you add local government, state government and Federal Government taxes, dues, levies, )and whatever else they like to call them) we pay almost 70c in every dollar we earn to our government. And i don’t feel like i am getting value for my money stolen from me. We do we continually hear that the rich must pay – i will guarantee they more more in Dollar value (maybe not in % value) as the poor, but when was the last time a poor person took the risk and started a new business that employed many people, created export income and so forth. so why shouldn’t they or anyone reap the benefit of investing in an essential item for people – shelter. So what it also goes up in value, but as a landlord i have also had to ay the cost of unpaid rent, damaged houses, poor demand when i wanted to sell, etc. I take the risk of providing a roof for some bleeding heart – who defend those who will not help themselves. Yes i do believe we have the Truly Poor amongst us, but i am not responsible to prop up every druggie, gambling addict, or whinged who refuses to do a hard days work for a fair amount of pay!
If i work hard, Take an enormous risk to further my and my family’s future, WHY SHOULDN’T I GET A BENEFIT LIKE EVERY BODY ELSE!!!
“But when was the last time a poor person took a risk and started a business …”
Are suggesting the negative gearing rate should be reduced and opened up to all business ventures not just proving rental properties?
What a great idea! We really should start trying to make our super by making peo
How about we get rid of negative gearing and reduce income tax at the same time? Only problem is that would require we reduce the size of government and that’s unlikely.
If they abolish negative gearing the property market will collapse in my opinion. Even though my properties are all positively geared, i will sell everything as soon as i can.
Which is why they probably won’t abolish it. But if they do, I hope you’re at the front of the line.
As an investor I would prefer no changes. The government will be in a lot of trouble if negative gearing is scrapped. The private sector, who provide affordable housing, provides society with housing that the government can’t afford to invest in to meet society’s needs – both money and management. Whether it be new or existing housing, people need to rent as they can’t afford to buy or choose not to buy.
That said though, I think it would be fair to remove the CGT tax concession. If an investor wants to run a business to make a profit, let them pay tax like all people in business. This will stop “renovating flippers” and people building just for short term gain rather than long term investment. Many investors will endure great losses in income per year (knowing they are deductable) but then knowing they only have to pay 50% tax on a profit on sale which could be potentially 10 times more in 2-3 years.
First home buyers will always complain about the same problems. Todays generation wants the house, the car, the 50″ screen tv etc NOW! What happened to buying a small 1 bedroom unit and getting mum & dad’s old couch and bed and then with a bit of hard work, working two jobs, then upgrade to a bigger property in 5 or 10 years time? I went from no money to a $2.5 million property portfolio in 13 years doing it “the old fashioned way”.
How about the USA capital gains tax law? If you sell an investment property and roll the profit over into another house, you pay NO tax. It’s only when you realise the gain by not reinvesting that you pay tax. It’s called a 1031 Exchange. http://www.investopedia.com/articles/06/section1031exchange.asp
It seems the opinions here depend on whether you’re an investor or looking to buy a home. Clearly, housing is less affordable today than it was 10, 20, 30, 40 or 50 years ago, by just about any measure you choose.
In 1975, the median house prices in Sydney, Melbourne and Brisbane were $34,300, $28,700 and $23,700 respectively. The average wage was $8,133, which means a Sydney house represented 4.2 years of wages; a Brisbane house just 2.9 years.
Today, the median house prices in these cities represent 6-10 years of wages. That doesn’t sound like a fair go to me.
Part of the problem, of course, is the cost of construction today. Blue collar workers often earn more than those with university degrees. Plumbers want $100 an hour to dig holes. They only need to know two things:
1. What day is pay day?
2. What flows down hill?
But seriously, I don’t want a McMansion. My home in Brisbane was 97sqm, and I had a wife and two kids at the time. (Now we have three kids.)
Read the ACOSS report if you haven’t already. It’s compelling.
Good points Michael. Tradies are VERY well paid in this country. But who can blame them for charging what the market will allow? It’s interesting to consider how the whole system would change if credit was not cheap and easily accessible? What if we scrapped the RBA?
I’ve long held the belief that the government should be in charge of issuing currency, and the RBA should be scrapped. At the very least we should set up our own Infrastructure Investment Bank with government-issued currency.
I have been following these forums for the past few months and this topic is important enough for me to engage in the conversation. With regard to any possible changes to CGT or negative gearing legislation can someone wiser than me please explain a fundamental question.
If residential investors leave the market en mass, would not the resulting flood of available properties keep the prices stable or even reduce them slightly enabling some existing tenants to enter the first home buyers market and therefore keep the existing supply/demand and property values and rents stable? Basically all that will change is that a large number of tenants would become home owners. What fundamental am I missing here?
The resulting flood of available properties would result in an oversupply and a massive drop in values making homes less expensive. However, the other hurdle for renters looking to own would be available cash reserves for deposits. And that’s assuming there was not a credit crisis and the banks were still loaning money.
As a Chartered Accountant and property investor for over 20 years,I cannot see why we cannot achieve a compromise deal which both protects the revenue base, and encourages residential investment to supply an adequate base of rental properties.
I would therefore recommend applying a sliding scale of 10% exemption a year to a maximum of 50% for the CGT discount i.e. if an investment property is sold in the 2nd year 10% discount applies, 20% in the 3rd year etc. This would encourage investors to hold properties for the longer term which is for the benefit of all.
Secondly, the interest allowable as a tax deduction should be limited to a loan that does not exceed 80% purchase of the purchase price i.e. on a 90% loan, only the first 80% can be claimed as a deduction, and the balance of 10% is foregone. This would stop the high income earners exploiting the benefits of negative gearing, and encourage genuine investors. it is quite an easy calculation so the rule would be easy to implement.
Negative gearing will NOT be abolished by any government. They may restrict it to new homes but that’s about it. WHY? Because its a PONZI scheme. 30-40% of new homes goes to tax. If you don’t agree google it and you’ll see. This 30-40% plus future land tax, rates etc, goes into the coffers, faster then the negative gearing benefits. That’s why they keep doing it. I have bet everything on it continuing
.
Good point Andy. Government does not win when property values decrease. But what if the other PONZI scheme – sovereign debt – unravels?
In other countries eg USA capital gains are taxed at a flat rate of 15%.
http://en.m.wikipedia.org/wiki/Capital_gains_tax_in_the_United_States
So a tax rate of 48% less 50% discount is an effective rate of 24%.
Seems high in comparison.
Indeed @HamishBlair, not to mention the 1031 exchange – http://www.investopedia.com/articles/06/section1031exchange.asp
Forget the 1031….the best deal around capital gains tax here in the USA is
“qualifies for exclusion of $250,000 gain ($500,000 if married filing jointly) if the following is true:
•You owned the home and used it as your main home during at least 2 of the last 5 years before the date of sale.
So basically every 2 years you can make $250/500k in capital gains on your primary home tax free :)
Whenever there is a shortfall in tax revenue, it’s the individual taxpayer that seems to be the target. In the end it looks like it’s the taxpayer who is funding nothing more than politician’s salaries, and what’s left over might make its way towards filling a pot hole in a road or two. Where has and where is all the money going, is my first question. I sure as heck don’t believe my taxes are being spent wisely (especially after working alongside a government department recently – OMG!!! the waste is incredible). How about the government starts at the big end of town to eliminate profit shifting to low tax/no tax regimes? This might be a bigger windfall for the government coffers than would be the case from changes to negative gearing. A few things I personally would like to see : companies who shift Australian jobs to cheaper offshore countries should not be able to claim a tax deduction for the cost of the offshore labour nor any costs associated with the moving of the jobs. Executive salaries (including all share and other compensation) above a threshold should not be deductible (eg. $1M per executive threshold and anything over this is not deductible to the company). Companies who employ 457 visa holders here locally in Australia should not be able to claim a tax deduction for the labour cost nor any costs associated with those employees. Companies should not be permitted to claim a tax deduction for intercompany transactions with offshore entities (this will curtail the huge issue with transfer pricing and would be enough to push us into surplus within the first year). Sounds extreme? I guess the government keeps going for the easy target – the individual tax payer. What do they have to loose? Individual tax payers don’t contribute as many donations to political parties as the big corporates do, so as usual, keep working hard, pay more of your hard earned money to the public purse, and see nothing for it.
Thanks for the comment @mymoney. I’ve always thought politicians raising money from corporations is the most obvious conflict of interest. But no one seems to care.
To buy my first property in Cronulla 30 years ago when I was 25, I maxed out 4 credit cards and borrowed $2000 from Auntie Irene just to get the deposit. On top of that I took 2 mortgages, a First Mortgage at 12.5% and a private Second Mortgage from a generous old lady in Mosman at 14.5%. All that on a wage of just $87.50 per week. I did my own conveyancing at the time to save money and my solicitor understood the lack of money for 2 young kids starting up and basically said pay my bill when you have the money.
Talk about starting small and working up, I could not even afford to live in that apartment, I had to rent it out and continue living with my parents. The only way I could afford to maintain that property and provide a roof over my tenant’s head was to tax deduct all things possible – meaning Negative Gearing.
I know this is not the forum for my story but the proposal of changing Negative Gearing and CGT is supposedly to increase housing affordability. Rubbish, the true reason is that the Government just wants to increase it’s coffers. They see all this money running around i.e. Tax Deductions, and they want to steal it from you. They couldn’t care less if you can afford a house or not. For a start If they did care they would drop Stamp Duty like they promised when the GST was brought in in 2000. However when they saw how much money they would loose then it was a different story wasn’t it. Sounds just like the WW1 comment by zzscci earlier re: income Tax. Same story as the toll on the Sydney Harbour Bridge – even I could have paid it off in 70 odd years. On the real social point however, the thing that will improve housing affordability can’t be changed by government policy. It’s the fact that young people need to get out and work for what they want. There is no free lunch. Stop paying for the mobile phones, social networking and instant gratification and put the cash to better use. What’s the problem? Things could not be better – interest rates at around 4%, lending to 95%. Anyone with a job and a Credit card with a decent limit can go out and buy a property tomorrow.
If Negative Gearing rules are changed then it will destroy the real estate market, prices will drop temporarily, sales will go down eventually, rents will skyrocket since owners will need to cover their costs, and then guess what, Stamp Duty will fall. This government must be making a killing in Stamp Duty at the moment the way the prices are going.
This government and previous rulers have had a propensity to try to stop people from getting above the madding crowd, look at the Luxury Car Limit in the 80’s to stop execs from deducting their Porches against their salaries. Then negative Gearing was stopped in the Charter Boat industry about 7 years ago. It killed the industry. Basically the Tax dept said you could only deduct up to the amount of income you received. So with an asset that continually declined, what was the point of being in business. Luckily I got out in time.
Bigger fish to fry here though, I doubt the government will change the rules since there is so much at stake, I guess an election loss is the primary problem and then probably most of them own investment properties anyway.
However if it is changed, then I will be out the door pronto and my $10M of property providing housing for so many people will also be on the block.
My husband and I are probably the typical moderately successful ‘Mum and Dad’ investors people refer to. We’ve been holding investment property for about 17 years and gradually increasing our asset base to pay for our retirement. In our early 50’s, we are getting there. But it is NOT EASY.
I would like to agree with all comments about first home buyers expectations. I have experienced this with my own children. Unfortunately we’ve raised a more ‘entitled’ generation, and their expectations are generally to live in suburbs as good, or better than their parents, to travel prior to settling down (rather than saving) and to even expect parents to help with deposits, renovations etc. Not to mention living at home for much longer than past generations, in many cases.
Secondly, we’ve personally had to work extremely hard to be able to maintain our properties, with something needing doing most weekends. Also, dealing with tenants can be no-one’s idea of fun when things go wrong, not to mention periods of vacancy, damage, etc. Sure, this may not affect wealthier people, but it does mean that for the average family, making money in property can be very hard work and I think those people deserve any profits they make as most people would not want to do it! There is a reason by only one in ten investors own multiple properties. I often feel like we are a small branch of the Housing Commission, and definately provide a service in the form of affordable housing.
Therefore my hope is that negative gearing and capital gains changes are restricted to those on very high incomes. Otherwise people such as us are going to be less financially independent as oldies, which will benefit noone, lease of all the generation below us.
Good points @Geraldine-M. This younger ‘entitled’ generation may be getting a rude awakening.