What Investors Can Expect If Negative Gearing Gets Scrapped
Just over a year ago, I posed the question, “Will Investors Soon Lose the Negative Gearing and CGT Benefits?” Well, it seems the chances just got a lot higher.
Last week, Opposition Leader Bill Shorten shocked the housing industry when he announced Labor’s plans to limit negative gearing to new homes and reduce the capital gains tax discount to 25 percent. Anyone buying after July 1, 2017 would be affected by the change. All previous purchases would be grandfathered under the current legislation.
On the surface, the Coalition appeared to be outraged, declaring that such changes would “severely distort” and “decimate” the housing market.
But then they countered with their own plans for a reform of negative gearing, one that would impact only a small percentage of their electorate. Treasurer Scott Morrison proposed to either cap the number of properties that could be negatively geared or perhaps limit the size of the annual tax deduction that could be claimed.
As you would expect, everyone working in any industry propped up by high property values is freaking out. Here are just a few responses from the more prominent real estate activists:
“With the Australian property market in short supply, it would be seemingly remiss of the government to change its current stance on negative gearing and further constrict supply. At the end of the day, both investors and renters are set to suffer if changes of the nature proposed should come to be.”
- John Flavell, CEO, Mortgage Choice
“Negative gearing promotes private investment in the rental market, both stimulating economic activity and taking the pressure off social housing and the public purse.”
- Graeme Wolfe, chief executive of industry policy and media, Housing Industry Association (HIA)
“Grandfathering simply locks these people into holding the properties they currently have. It will stifle turnover and make these people angry… this will exacerbate Australia’s undersupply of housing and infrastructure. This is the wrong approach for the challenges we have to face.”
- Ken Morrison, CEO, Property Council of Australia (PCA)
After hearing them, one would think that the world as we know it is about to end. Would the winding back of property tax concessions really be all that bad?
Here are four impacts Labor’s changes would force upon property investors:
1. Home prices in 2017 would get volatile.
If Labor gets their wish, you can expect some jostling and positioning in the property market next year, as investors line up to be grandfathered under the current tax laws.
The first homebuyers grant was introduced on July 1, 2000. Naturally, the property market went quiet in the first half of the year and prices dropped as would-be homebuyers sat on the sidelines waiting for the new benefit to kick in. Then after July 1 that year, prices began to rise again.
A similar phenomenon would likely take place next year, causing a mini boom in the first half of 2017 as investors rush into the market. Then after the new tax laws are in force, prices would drop back, as investor demand wanes.
All other things being equal, the drop in prices would likely be nominal. If however unemployment data is disappointing, interest rates rise or something crazy happens overseas, the drop could be more significant.
2. Speculative investors would have to start caring a lot more about cash flow.
Photo by Simon Cunningham / CC BY
For years, we’ve had tax laws that encourage investors to buy properties that have little merit apart from a hope for capital growth. On the assumption that all assets inevitably increase in value, investors have been able to justify their losses with an income tax offset.
If these laws change as Labor hopes, then investors will need to start itemizing operating costs and learn how to crunch the numbers. The little phrase “net operating income” will become a lot more popular. Real estate agents will stop quoting the “yield” of a property and instead start talking about the “cap rate.”
3. Positive cash-flow deals may be a little easier to come by.
With less investor demand in the existing housing market, a drop in home values in the second half of 2017 would be likely. As long as the RBA remains keen to lower interest rates, I wouldn’t expect the bottom to fall out of the market just yet, but there would certainly be a market shift in favour of the buyers. This would make positive cash flow deals a little easier to find.
Some have said that scrapping negative gearing would lead to higher rental prices. Before you get too excited about yields improving by a boost on the income side, you may want to take a closer look at history. There seems to be some holes in this commonly promoted theory.
4. Cashed up developers could end up being the big winners.
For high-income, buy-hold-and-hope investors who insist on acquiring real estate to lower taxable income, they will still have the option to buy something brand new. Labor’s proposition would likely funnel more investment capital toward new supply being offered by developers.
Developers may also benefit from the drop in property values in the existing housing market, if prices do in fact fall. One of the big complaints of developers now is that it’s hard to find deals that stack up, especially in and around Melbourne and Sydney.
Conclusion
Who knows? Maybe Labor’s plan wouldn’t be so bad after-all. That is, unless you’re one of the many who leveraged back up to 80 percent to buy another property or two last year. If so, you may find yourself in crisis mode.
What do you think? Does Labor stand a chance getting elected on this platform? If they did, what would the impact be upon our property market?
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The thing I object to most about any proposed changes to -ve gearing is that it seeks to treat property investors differently to investors in other asset classes and business owners. They seek to make property investors second class citizens. The long term downside effect will most definitely be less direct investment in residential property, which could not possibly be a desired outcome.
The more annoying aspect of this, which is seldom discussed, is that the major drivers of property prices are monetary inflation (the reduction in buying power of the currency over time) and regulations which increase the risks and costs associated with increasing the housing supply. Nothing is proposed to be done about either of these things and nothing will be!
The result will be short term pain for both property investors and renters as prices drop and rents go up. Long term property investors may do even better than they would have otherwise and property developers will certainly benefit as they are given a pricing advantage over those selling existing properties.
This is good.
1. Rents will have to increase because you can no longer claim interest as a tax deduction. It will also effect depreciation. So Add interest and depreciation lost plus about 2 % over interest as a loss in profits and claim this as an increase.
2. Quaranteen or accumulate all losses to be used against future profits or capital gains tax. This way future profits and capital gains tax can be reduced.
3. need to go to bank to borrow for losses. This will increase costs for sale.
4. If purchase more than 3 properties you can seek permission from the tax office not to be treated as a rental investor but as a business. As a business you will then be entitled to claim losses against other business income. Plus depreciation is calculated differently for businesses. Depreciation is calculated not on original cost price of the building BUT on the price you purchased the asset for. You cannot claim it as a deprerciation of a home but as a investment asset.
5. Now you can make arrangements with seller and the bank to buy the asset under a Hire Purchase contract. Under a hire purchase contract say of 5 to 10 years, you are entitled to claim hire or rental charges as a tax deduction. This will mean cost of land and building and everything else is written off over 5 to 10 years.
Please check all the above with accountants and tax agents. This is what I have been told works. If it is so. Please inform me as I will buy 3 or 4 investment assets as a business and get massive writeoffs against business profits.
Hi Alistair,
“The long term downside effect will most definitely be less direct investment in residential property, which could not possibly be a desired outcome.”
I totally agree with you there – and yet, over and over, I hear “Investors are preventing firsthome buyers from getting their own place” – that nonsense adds fuel to the Labor fire. So they would rather get rid of investors?
First off, how many investors will pay “above the odds” to get a place? Any home buyer wanting to bid above an investor wouldn’t need to bid too highly.
Second, by purchasing houses as rentals, we make accommodation available for all of those who are “starting out” and haven’t yet got the years, the experience, or the deposit to afford a place of their own. So we supply a service that is subject to market forces like all others – if we put our rent too high, we will be undercut and lose money. Conversely, if more renters want to rent, and digs aren’t available, up go the rental rates.
Third, having tried this 30 years ago, and the angst it caused, why does Labor think it “makes sense now” to re-introduce these changes? Get out of the way and stop fiddling with “the market” lest their actions promote rental hikes that punish all those who must still rent !!
Fourth, they talk of John Howard “introducing a 50% discount on CGT” as though it was a gift. It wasn’t – it REPLACED a system of indexation that prevented an investor being slugged for Tax on Inflated Values as our dollar values headed South. No gift – just a trade-off. Without it, we would have had a repeat of 1985-86 a la Labor !!
Fifth, I also agree with Alistair that property investors should not be treated differently to other investors – why should we? We are helping ourselves by helping others, so maybe way more benevolent than those who collect art, gold, or buy shares. Make it difficult for us to invest in real estate, and watch us become less benevolent !! ;)
Benny
I have put a deposit on a development which settles sometime in 2017.
Does ” All previous purchases would be grandfathered under the current legislation.” include properties not yet settled on?
With real estate transactions, the purchase date is generally the date of the contract, not the date of settlement.
Great post Jas! If only we had a crystal ball into the future to solidify your position in the market. We’ll have to listen to the market carefully for and hold on tight coming into 2017.
Indexation was a fairer system than a flat 50% CGT discount, in my opinion. When inflation is in the 2-3% range but properties are rising at 7-20% per annum, it doesn’t take a super accountant to work out that the government is ripping itself off with a 50% concession.
The thing is, negative gearing HAS made it more difficult for first home buyers. (Along with low interest rates, mining booms, Chinese investment, etc.) Australians are among the most indebted in the world per GDP, and that’s largely because of our insanely expensive houses. Until 40 years ago, houses cost about 3.0 – 3.5 times the median wage. Back then most families could pay off a home in less than ten years on only one income. Now they are 8.0 – 12.0 times the median wage, mum and dad have to work, which usually means two cars, and we need to pay “professionals” to help us look after our kids.
Negative gearing is (ab)used by those on very high incomes. I wonder how many doctors have 50 investment properties and pay next to no tax?
There are already restrictions on negative gearing for luxury boats. (See Charter Boat Tax Ruling TR 2003/04 released in May 2003.)
Few aspects that were ignored in these discussion: If -ve gearing is removed
(i)Will the CGT be still payable on the profit when you sell? If one gets no tax deduction on an investment, that makes it equivalent to an owner occupier property. Why would govt allow owner occupiers to get away with zero CGT while forcing it on investors? I think there will be a huge backlash and may actually lead to people disguising investment property as owner occupier. Infact, once this loophole is discovered, CGT will also be levied on owner occupiers. So in the long run, both investors and non-investors will have to pay CGT. Perhaps this is the ultimate intention and investors are only being used as guinea pigs in this experiment.
(ii)How will state govt and local council react to a massive hole in their revenue resulting from low rates and stamp duty due to a massive dip in property value. I hope the Federal government will be happy bail them out. Or someone needs to remind them that stamp duty and rates are based on property value.This reminds me of ACTEW in the ACT asking people to use less water and then complaining few years later about low revenue generated. Reason? water consumption dipped to 50% across the ACT. Simply idiotic that no one in the entire bureaucracy thought about this at the beginning.
(iii)Negatively geared amount is included for assessable income when determining eligibility for family assistance purposes. Removing negative gearing will simply put some people back below threshold for family assistance – and guess who pays for that?
(iv)If and only if rent does go up with these changes, rent assistance payable by govt to people on centre link payment will likely go up. Again who pay?
The list goes on and on.
I am not an economist and I don’t know how much our govt is trying to rake in from these changes. However, I think in 2-3 years, it will be clear that it is a monumental mistake as the cost to govt overall will surpass the savings. Maybe someone needs to remind our politician of something called ‘unintended consequences’.
Good points.
One thing I will say… The deeper we go into a fiscal hole, the more government will find ways to increase revenue. Requiring CGT on personal residences is not out of the realm of probability.
I am in 2 minds over this, will it
A-Force rental supply to outlying areas poorly covered by transport and other infrastructure, further punishing renters OR
B-Provided demand stays strong encourage more knockdown and rebuild in inner suburbs which provide better more established neighbourhood services.
Or even possibly ,it could have negligible effect to renters. The lower income value conscious ones will be on the fringes anyway, leaving the higher income ones in the inner suburbs just as it is now.
It doesn’t matter anyway because Labor wont get in – Shorten is way less popular than Kim Beazley and he couldn’t make it. This idea helps people who already vote Labor anyway. Once the election is out of the way the govt will tinker with NG slightly to look like they have done something fair. Turnbull has shown he is a jellyfish (with GST) so there wont be any real reform . Remember Keating the reformer? He’s retired folks. Theres too many people with a vested interest keeping property inflated so no real changes will happen.
There is indeed a lot of power resting with those who want to keep propping up real estate values, not the least of which the RBA and banks. But less than 10 percent of the population has a vested interest in negative gearing. If the other 90+ percent of voters start blaming the unaffordability of housing on tax concessions for the “rich,” then the future may not be like the present. I wouldn’t exactly say that as a nation we’re moving away from an entitlement mentality. We may see power increasingly shift toward politicians who promise the most wealth redistribution.
…unless of course the two-thirds of Australians who own homes realise that they actually do have a vested interest.
The Property Council of Australia is running a petition to lobby the politicians to keep their hands off the current negative gearing arrangement. You can sign the petition here
http://dontplaywithproperty.org.au/?utm_source=search&utm_medium=cpc&utm_campaign=ngfeb
This could work out to be a good thing for investors you know….
eg. ROI will increase.
Note I said ROI and NOT “rent”, almost everyone says Rents will increase but its probably a mix of rents will go up BUT also property prices will fall.
Basically this will allow you to purchase MORE investment properties in comparison to the number of hours you need to work FOR that dollar amount.
I also agree with the comment above….its a stupid idea for the govt and it will result in less stamp duty revenue…..but hey it will get them votes and that’s all that matter to politicians.
Keep in mind however that although you wont be able to declare against your current income…..you will still be able to declare against future income.
Eg. my wife and I own investment property in Sydney but live/work overseas (higher earning potential per hour worked).
Currently we choose to run our investments at a slight loss (eg cumulative its always between -2,000 to -10,000pa) anytime we are about to run a profit we leverage and go buy another property kicking it to somewhere back around a 10k loss.
My point being and a lot of people don’t realize this is that as an expat we CANT negatively gear today (basically this makes the whole -ve argument moot for us). What happens is we lodge Australian taxes and this loss carries forward. Our thinking is that in 20 years from now when we retire back in Australia…..it will probably take us 10 years or so before we have to pay any actually tax income as we ‘pay down’ the carried losses.
The same thing will happen with your rental properties, loss on the investment carried forward until rent increases OR you pay down the principle enough to pay down the income covers outgoing.
Consider it ‘delayed savings’, in the mean time the cost to purchase your next investment property went down 10% and your rents went up slightly :)
Turnbull recently said something similar: http://tinyurl.com/jzg2gqk
Looking at this debate, I can see problems on the horizon, which, from what I have been able to view, no one has picked up on.
The C.G.T., if it is curtailed and only applied from July 2017 to newly built dwellings, I can see that prices prior to July 2017 will be on a rocket, going upwards. Everyone will want to get into the market. My hope is that the lenders do not make loans easily available at this time. After June 2017, will the prices for housing hold, rise or fall? Look back to the G.S.T., introduced in July 2000. Prior to that date, everyone wanted everything delivered or invoiced prior to June 30. After that date, things died but slowly resumed to a similar pace to prior the introduction.
People that are in the market at that time that are forced to sell, that miss out on the June 30 deadline may get stuck with property they can not sell, so they drop the price to encourage someone to buy the property. This starts driving property prices down. Imagine a glut of property which no one wants to buy and buyers are dictating the price they are happy to part with their money. The glut of units in inner Melbourne about 10 – 12 years ago springs to mind. Foreign investors buying in units could get a double whammy due to movement in the AU$ against their native currency and the fall in value, bearing in mind the spruikers are often inflating the price well over the true market value.
With property, and I will stand corrected on what I am about to say: You go and borrow to buy a property. Pay $500K, borrow $400K. What happens in the event where there is a major correction in the market in the first say, 5 years, and prices drop by say, 35%? Is there not a clause in the mortgage contract which specifies that you have to have positive equity in your property? If this happens, and the prices fall, what is going to happen? It will start as a trickle of foreclosures, which, the financers, caught with property, will look to sell at fire sale prices. This drives the prices around that home downwards. This could then expose other occupiers and or investors to foreclosure due to negative equity. State and local governments will suffer due to reduced capital costs, but, they will increase the rates to counter that problem! As the rate of foreclosed homes increases, this could do a couple of things. Either hold the rents at current levels, or cause the rents to drop. Rents could increase due to renters being kicked out due to foreclosure and stock removed from the market. What is the standing on a valid rental contract in the case of foreclosure?
There is also the matter of income to property value. At this time, many places are way out of reach for the person working on basic incomes. Even with 2 incomes, it is still minimal chance of getting into a home. While the property prices are high, this favours the lenders, realtors and governments. Should they fall, it may make for affordable home ownership, but, what damage is going to be done to the lenders and governments primarily, and the real estate industry secondly?
Apologies for being so negative, and, I am hoping like hell that this does not play out here, but, from what I have been able to view, minimal respondents to the forums have thought past the basic idea and thought through the end game, so to speak. My request to people is to think things through from many angles and to look at multiple outcomes that may happen. My understanding is that it is called “Due Diligence”.
Hi Mal. That’s definitely a worst case scenario, but possible. Bear in mind with foreclosures however, the banks will be watching the market closely and may choose not to foreclose if it will do more harm to their books than good. About 15% of all homes in the USA still have negative equity. I recently spoke to a homeowner in the States who hasn’t made a mortgage payment in 3 years and the bank still hasn’t foreclosed.