Noel Whittaker: Negative gearing debate is back & pushing investors out of property market won’t solve crisis

Negative gearing is back in the spotlight, with several proposals to alter how property tax deductions work. Suggestions include banning negative gearing for properties altogether or limiting it to just two properties.

Advocates of these changes argue that current rules provide investors with an unfair tax advantage while locking first home buyers out of the market. But these claims don’t hold water. Negative gearing is not a huge tax loophole. Most property investors fall into the 30 per cent tax bracket, meaning the government covers 30 per cent of any loss, and the investor bears 70 per cent. That’s far from a tax rort. Plus, many of these losses are due to non-cash deductions like depreciation, which are recouped when the property is sold.

It’s crucial to consider how any changes would be implemented. No government heading into an election would eliminate tax deductions for existing rental properties. New rules would need to be grandfathered, which would discourage existing investors from selling, and deter potential investors from buying. It’s a zero-sum game. The real cause of the housing unaffordability crisis is unchecked immigration, which is fuelling demand.

There’s been much talk about what happened when Paul Keating changed the rules back in 1985, but people seem to forget that interest was still deductible – investors could “quarantine” their rental property losses. While they couldn’t offset these losses against other income to reduce their tax bill in the current year, they could carry forward the losses and apply them to future rental income or capital gains from the sale of the property. So the losses weren’t completely disallowed: they were deferred. Investors had to wait to benefit from the deductions until they had future rental income or sold the property, at which point the quarantined losses would be used to reduce tax liabilities.

Keating also altered the depreciation rules. He raised the depreciation allowance on buildings from 2.5 per cent to 4 per cent, and extended it to residential properties, which had previously been ineligible. In 1987, when negative gearing was reinstated, the rate was reduced back to 2.5 per cent, but residential properties were allowed to retain 2.5 per cent depreciation.

There’s a larger issue at play. Thanks to the Greens and their supporters, there’s growing resentment towards landlords among certain groups. This has led to onerous new rules, such as requiring landlords to comply with any “reasonable” request from tenants. These requests could include installing air conditioning, fitting security flyscreens, or allowing pets. Such changes make investing in property less attractive.

If there’s a silver lining to the constant attacks on landlords, it’s that it nudges investors to consider shares more seriously. In retirement, shares are far better than property as an investment. You don’t have all the outgoings — like land tax, repairs and rates — and if you need money, you can simply sell part of your investment and have the proceeds within a week. With property you’re stuck selling the whole asset, which may take months, and often face a large capital gains tax bill.

In most cases, shares outperform residential property, too. In 1990, I bought a beachfront apartment for $500,000. It would be worth about $2.5 million today if I still owned it. If I had put that same money into a share market index fund, it would be worth $10.4 million today.

Pushing investors out of the property market won’t solve the housing affordability crisis: policies that bring demand and supply into alignment do that. But creating uncertainty about property taxation may make landlords nervous — if large numbers sell their properties to owner-occupiers, rents will go up for the remainder. If not, landlords will try to cut losses, and rents will go up. As long as demand outstrips supply, housing will remain expensive.

Ask the expert

Q: I am 61 and semi-retired. I have $600,000 in super, and we have $50,000 left on our home mortgage. We also own an investment property worth $800,000 with an outstanding loan of $400,000. I’m wondering whether we should use my super to pay off the investment property or sell it, keeping in mind the potential tax implications. My thought is that by holding on to it, we could receive a steady rental income of about $2200 per month.

A: A major issue is the returns potential of the property and the performance of your superannuation fund. A good superannuation fund should be producing at least 7 per cent a year so by withdrawing $400,000 to pay off the mortgage you could be losing $28,000 in super in year one — of course this would increase as the fund continues to grow. You also need to think about what capital gains tax you would pay if you sell the property. If the property has potential, your best option might be to hold it and leave the loan as is so the rent covers the interest cost. With this strategy, you should enjoy both the capital gain on the property as well as on your super.