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Castles in the Air

By 2353NM

One of the points of difference between the Turnbull government and the Shorten opposition is negative gearing. We would all still be here next week if the current regime and the proposals were discussed in full, so how about we attempt to do the ‘helicopter’ version. Just keep in mind that this article is general in nature and doesn’t consider your financial situation.

Broadly speaking negative gearing is a method of reducing your taxable income. You do this by purchasing an asset where the expenses from the asset are greater than the income you gain from the asset. As the asset is ‘income producing’ and you lose money on it, you can take the loss from other taxable income when it comes time to doing your tax return.

To negative gear effectively, you need to purchase something that will remain steady or increase in value. So buying a car and leasing it to an Uber operator wouldn’t be a good idea because the car is almost certain to decrease in value, regardless of the use it gets. By contrast, property and shares are excellent choices as both asset classes can produce an income (income producing) and frequently the expenses incurred in the purchase and maintenance of the asset (interest, fees and in the case of property, rates, maintenance, body corporate and leasing fees and so on) can easily and quite legitimately outweigh the income received from the asset. When you add up the costs, take away the income and then subtract it from your income from other sources such as your job, if you’ve done it correctly, your income for taxation purposes reduces to something under $80,000 per annum and voila, you qualify for one of the lower levels of income taxation.

Traditionally property and shares rise in value over time, so as well as writing off your losses you can usually sell for more money than you paid when the time comes. This is known as a capital gain. Capital Gains Tax is where you make a profit on the sale of an asset and the government of the day puts their hand out for some of the profit. Simplistically, the tax is calculated by adding the purchase price to the price of any capital improvements (say a new kitchen and carport), then subtracting that number from the sale price less the costs of the sale (real estate fees, legal fees and so on). If you hold the asset for more than 12 months, the current practice is for the tax to be calculated on only half the profit. If you hold a property for say four years and make $50,000 in capital gains, the government will only tax you at your marginal rate as if the profit was only $25,000.

On Easter Monday, Fairfax titles around Australia were reporting one of the strange outcomes of the current negative gearing policy settings. To be blunt

Sydney’s housing affordability crisis is being artificially inflated by up to 90,000 properties standing empty in some of the city’s most desirable suburbs, experts say.

While there is always some variation in rental returns, it seems that property in areas with higher capital growth are statistically more likely to be empty. And we’re not just talking ‘margin of error’ stuff here: in Sydney City, Haymarket and The Rocks, one in seven dwellings (somewhere where people are allowed to live) is vacant. If you go way out west, areas around Casula and Green Valley have a vacancy rate of around one in forty-two. Melbourne isn’t immune to the empty property trend with an estimated 82,724 or 4.8% of properties across the city being empty.

Admittedly, some of the empty dwellings in Sydney City and Melbourne may be on the market, undergoing major renovation or people are on extended holidays — but certainly not all of them. Those that look at the real estate advertising, either on line or in the ‘dead tree’ format, would be well aware of articles discussing the current capital gains that can be made in real estate with barely a mention of rental returns. Late in March, the question was whether Hobart or Brisbane were the places to buy now as housing prices were likely to increase substantially in the short term.

While the Sydney market peters out, Brisbane and Hobart are warming up with the Australian Bureau of Statistics Residential Property Price Index rising 2.5 per cent in Hobart and 1.6 per cent in Brisbane over the December quarter.

Domain Group data for the 12 months to January 2016 also showed Brisbane’s median house price increased 2.5 per cent to $485,000, while its median unit price was flat at $410,000. Hobart’s median house price grew by 2.4 per cent to $340,000 and its unit price jumped 9.7 per cent to $290,000.

There are a few fundamental problems with property investment. While those who already own property in one of the ‘hot spots’ are laughing all the way to the bank — sometimes to get the equity loan for the overseas trip, the massive renovation or the fancy car — those that grew up or rent in the locality can’t afford to purchase a first property in the area they are familiar with. In addition, those who purchase properties for investment can’t carve off $50,000 worth of the property should they have a requirement for the cash in a hurry.

The real problem here is that people are buying property for the wrong reason. A property is a place for people to live. It should be noted that a property only has to be available for rental before the ATO will allow negative gearing, there is no requirement that the property be rented, the property be advertised for rental if it is vacant or the rent value be appropriate for the market. The cynical could suggest that the way to maximise your negative income from a property is to leave it vacant as no income less expenses adds up to a greater tax loss than some income less expenses. The short term pain is alleviated by the increase in value of the property when the property is sold due to favourable capital gains taxation treatment where you keep something over 75% of the profit.

Like property, there are a number of factors that usually indicate if a share purchase should be made. In contrast to the oft repeated mantra of property sales “location, location, location”, the intrinsic worth of a share to an investor is usually calculated using a number of ratios. They are Price/Earnings Ratio; Earnings Yield; Return on Equity and Dividend Yield. This Fairfax article discusses what each of these terms actually means, should you wish to know more. For the moment let’s just consider one point; most of the share indicators are based on the price of the share in relation to the dividend (payment of a small proportion of the profit from the company’s operations).

Property prices and affordability are currently based on what capital gain is likely to be made over the short to medium term, not what rental income is received should the inner city unit you have purchased as an investment be actually used for its intended purpose. To be fair, some of the demand for property is generated by overseas residents attempting to purchase assets in Australia but this is estimated to be about 15% of the market, rising to 20% by 2020.

The point to all of this is that investors have manipulated the property market with the co-operation of the government. They have artificially increased the value of property, diminished the ability of your and my kids ever owning a place to call home, created the potential for a housing bubble and potentially reduced the number of ‘real’ properties available for rental or purchase which has caused a housing shortage.

There is also a waste of resources in having one in seven properties in Sydney City empty. The electricity and water supply organisations have to assume the property will be used for the intended purpose when calculating the potential demand for electricity, water and other services. This causes an overbuilding of infrastructure to service the affected areas — capital that could better be used to reduce utilities prices.

It seems that if you buy a property you can game the negative gearing/capital gains tax systems better than if you buy shares. If your property is empty, there is no income to account for when ‘losing’ money on the rates and taxes incurred when owing a property. Most Company Boards wouldn’t consider a request that they don’t pay a dividend this year solely to assist you in maximising your potential for reducing your taxable income.

Surely any investment decision should be made on the return expected on the investment, as well as the potential for profit on the sale? Most are, but for some reason the potential rent that could be earned on property is discarded. Some are happy to only accept the potential future capital gain assuming that someone in the future wants to buy a five-year-old property that no one has ever lived in. It’s too bad if the market does crash for some reason or other. Ironically, the rental income per square metre in inner city Sydney would be significantly greater than the rent you could expect to receive at Casula or Green Valley, so the ‘price/earnings ratio’ of an inner city property would be more attractive than the ratio for a property in the outer suburbs where vacant properties are statistically fewer.

Turnbull and the Coalition want to keep the existing policy settings; probably a good thing if you need to reduce your taxable income to under $80,000 and can’t use other tax management practices such as companies, splitting income etc. Shorten and the ALP don’t. Shorten wants to remove the ability to negative gear property unless the particular property is a ‘new build’. While the first owner of a property could negative gear the property regardless of whether a tenant was in place, logically a long standing tenant in a property paying a realistic rent per week would become the preferred situation if the property was onsold.

Shorten also claims that considerable research, time and effort has gone into the ALP’s proposed policy, that will go part way to addressing issues such as tax avoidance, housing availability and housing prices being out of reach if you are unfortunate enough to be trying to purchase your first property somewhere close to services like shopping, education, transport and health care in one of our larger cities.

It is probable that investors will return to the fundamentals of investment should the ALP scheme be implemented leading to a stabilisation of housing prices, an increase in property available for rental and slower rates of housing price growth. This will come about because investors won’t be pushing first home buyers out of the market and properties won’t remain empty for years.

There is also significant upside when it comes to eliminating the budget deficit (we’ll leave the inevitable discussion on Modern Money Theory for another time). The Balanced Budget Commission, established by the Committee for the Economic Development of Australia, believes the budget deficit can be eliminated by 2019.

The Commission finds that in order to eliminate the budget deficit by 2018‒19, spending should fall by $2 billion and revenue should climb by $15 billion.

It sets out five options for achieving that goal, all of which include a cut in the discount applied to the capital gains tax along the lines proposed by Labor.

In response to Turnbull’s claim that removing negative gearing and increasing capital gains tax will reduce investment, Commission Chair Mr McClintock said:

It doesn’t mean it is a bad activity, but you can say there is too many billions of dollars going into that activity and we cannot afford that. With things like negative gearing, the inflation rates are lower, there is a strong argument to suggest you can lower that and still produce an environment where people are willing to invest. Our judgment call is that, yes, of course, it will have some marginal impact, so will everything, but it’s a manageable impact.

Really, it doesn’t take the skills, research and knowledge of the CEDA to suggest future affordability of housing and availability of properties for rent or purchase outweighs the perceived right of others to reduce their contribution towards the provision of services to the entire community — aka minimisation or avoidance of taxes. Unfortunately, only one of the two major political parties has demonstrated that they see the connection.

Also by the author:

Perceptions of corruption

The small government myth

Malcolm’s Magic Pudding

May your god go with you

This article was originally published on The Political Sword

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  1. Florence nee Fedup

    I suspect one would first need to have a income where one is paying enough tax to make effort worthwhile. One has to have the wherewithal to begin. Can’t see many on low incomes being involved. Just wouldn’t make sense.

    My other concern is having so much national savings and investments directed into housing.

    Doesn’t sound innovative, exciting or agile to me.

    Especially when it is pushing first home owners out of the picture, Doing nothing keeping rent down. Nothing to create new housing stock.

    Howard added to the distortion when he changes the rules on capital gains tax.

    it is not an exciting time for young people trying to put a roof over their head, a refuge for their families.

  2. bobrafto

    your income for taxation purposes reduces to something under $80,000 per annum and voila, you qualify for one of the lower levels of income taxation.

    Another way of putting it is ‘The government will pay a majority portion of the property for (lucky) you.’

  3. Florence nee Fedup

    Nice to know a childless social worker & plumber husband manage to get first home by living with mum & dad. Not exactly low income struggling family.

    With a plumbing business, negative gearing would make sense. Does putting last home purchased in year old child avoid more tax.

    That would be in trust fund I assume.

    PM was showing what one can do with clever accountant and above average income.

  4. John Kelly

    Oh how the Liberal party love to demonstrate what they think is their superior economic management. By opposing changes to negative gearing they think a scare campaign that warns of a housing price collapse will do the trick this time around. Abbott ran with debt and deficits, Howard liked interest rates. Neither of those were true. Nor is negative gearing. This time, I think the electorate has wised up.

  5. Steve Laing -

    You are right Florence. It only makes sense if your earnings are high enough that you can afford the cost of the mortgage(s). If your salary isn’t large enough, and your property isn’t renting, then potentially you can find yourself in financial trouble as those mortgages still have to be paid. I’ve known some people on lower incomes dabble in negative geared properties, and it has generally all ended in tears – it is highly stressful, and they’ve never made any real money out of it. So it really is a benefit aimed at the already wealthy, despite the government attempting to suggest that its for ordinary mums and dads. More duplicity, as we have come to expect.

    This article in Buzzfeed shows exactly why the Liberal cabinet have decided to drop the reform of negative gearing…

  6. Carol Taylor

    Clearly by limiting negative gearing to new constructions the result will be an increase in the housing stock, something the Libs like to blame on the states by insisting that land is released for ‘affordable housing’. The only trouble for the very well to do negative gear-ers (compared with the ‘mums and dads’), is that your capital gains is not nearly as healthy than when you are engaged in churning inner Sydney and Melbourne established houses and apartments. Hardly worth one’s while investing in the ‘burbs.. But what a WASTE of money and resources, instead of Innovation Nation we have an economy revolving around property churning. Jobs? For RE agents, accountants and solicitors only.

    Indeed Florence, that is exactly what the PM was showing us – that if you have money and resources, you too can avoid paying tax. Hip, hip hooray for tax avoidance..such heroes, being able to sponge of the less well-heeled.

  7. paul walter

    So profitable to keep people on the streets..operates diametrically opposite to what those who thought up the original concept had in mind, perhaps.

  8. Carol Taylor

    John Kelly, I do believe you are right. The LNP are attempting to run scare campaigns based on banks and the defence of people who own multiple properties. Indeed, this should be viewed with scepticism. Howard was in a place of increased ‘wealth’ in which even Howard’s Battlers were going to be reaping the benefits. This time around, wages are flat, work increasingly temporary or part time, massive rorting of the system by the wealthy is well publicised, and you have a government seen to be protecting its own personal interests (the Turnbulls have around 10 investment properties plus park their money offshore). The irony of it all, trying to preach austerity while protecting the interests of the ultra-wealthy.

  9. Carol Taylor

    Paul Walter, and so profitable to keep people poor..a ready made supply of tenants.

  10. Jaquix

    I watched Turnbull and Morrison acting out their little charade yesterday – and I have a few questions about it. Why did they drive there in Comm cars? Why not public transport? WHY DIDNT THEY STAND OUTSIDE MALCOLM’s MANSION AND SAY “THIS TOO CAN BE YOURS – IF YOU NEGATIVELY GEAR WITH US” ? Why do the Libs wear blue and white check shirts on the weekend, is this official issue “uniform”:? Why did the man buy a house for his daughter, and expect other taxpayers to give him a big discount on the costs? Is it because she couldnt afford to buy a house herself? Is she paying a fair market rental? Is she on a benefit, and possibly collecting “rent assistance” of $80 as well? Why did this man say that “if negative gearing goes I will have to sell the house?” (Labor’s policy will not affect existing owners). Why do the Libs obfuscate by putting up misleading statistics about neg gearers’ “average taxable income being under $80,000 p.a., so that people think that is their gross income Someone on $200,000 p.a. (like, for instance, politicians who love neg gearing) could neg gear several properties so that they got their “taxable income” down to $80,000.
    Congratulations to the author of this article. I hope the Labor team pick up on the point he makes about high vacancy rates in inner Sydney. Shame it wont be published in mainstream media, certainly not by Murdoch.

  11. Terry2

    A well informed commentator was interviewed on ABC radio this morning. I didn’t catch his name but he pointed out how negative gearing is creating an artificial bubble in the existing housing market and effectively locking out first home buyers.
    Inevitably, an investor who is prepared to make a loss making investment – that is outgoings exceeding income – is only doing so to get the tax offset and take advantage of market bubble that they have helped create and , of course, the discount on capital gains when they sell.

    The faux campaign by Turnbull and Morrison is disappointing in that it assumes that Australians are stupid.

    The Labor policy is well calibrated and they are to be commended for tackling from opposition a very touchy political subject.

    If Mums & Dads are going to be deprived of this rort, maybe Malcolm should recommend that they send their superannuation off to the Cayman Islands as he does : another rort !

  12. SallyK

    The speculative vacancies research in Melbourne was done by Prosper Australia:

    For an overview of Geonomics they have a summary on the website

    Turnbull’s support of negative gearing is consistent with centuries of the domination of government tax policy to favour speculation in land and shift the tax burden onto those who work for a living. Fred Harrison’s latest book “As Evil Does”, examines this history, beginning with Magna Carta.

    That we treat land, the Earth, in the marketplace like any man-made product and privatise its economic rent is at the heart of what is wrong with our civilization.

  13. Marcus

    Every dollar pumped into existing housing stock-for purely tax minimization purposes-is a dollar not being invested in the retail, research or manufacturing sector. For that reason, alone, these tsx subsidies need to be scrapped IMHO.

  14. Kyran

    There was an article by Ian Verrender this morning that mirrors the sentiment of this article;,-we're-just-tinkering-with-tax-dodgers/7354558

    After reading both, I couldn’t help but note the similarities. The oddest thought came to mind.
    Imagine a world where privatizing profits and socializing losses was not only acceptable, not only realistic, but admirable? Imagine a world where ‘socialism’ is a construct for the rich and ‘capitalism’ is a construct for the poor?
    Then I watched a DVD called “The Big Short”.
    Then I read an article on ABC about some git trying to fuse ANZAC Day and negative gearing.
    “Mr Robert, who resigned as assistant minister for defence amid controversy earlier this year, tweeted that “there are more defence force personnel who use negative gearing than surgeons, judges, anaesthetists and psychiatrists combined” shortly after 10:30am today.”

    Lucky for him he wasn’t an SBS sports journalist. Otherwise, talcum would have nailed him.
    The epitaph of The Big Short included all of these silly facts. Only one banker went to jail in America. None of the ‘too big to fail’ legislation was ever introduced. The banks started bundling ‘bad debt bonds’ again in 2015. This model is both broke and broken.
    Lest we forget.
    Having had the privilege of many conversations with many returned servicemen and servicewomen, over many decades, I can’t recall any who went to fight for the banks, the insurers, the investors, the corporates. And I have never heard any of them speak of politicians in anything other than ‘disparaging’ terms.
    My link to ANZAC Day in terms of government regulation of our corporate sector is tenuous, aided and abetted by a cretin (Robert). How is it that all of what was worth fighting for is now merely a commodity we now want to sell?
    Thank you 2353NM and AIMN. Take care, and never forget

  15. diannaart

    Excellent read on NG.

    It is simply easier to play the system the more money one has. Also, an ability to believe oneself superior to others for cheating the public on their taxes is de rigueur for these greedy liars.

  16. Jack Russell

    The ignorance of some is appalling, but worse, is the effort that the LNP and their networks put into maintaining that ignorance, not to mention their relentless attempts to create more of it. If they’re so clever in every way, one has to wonder how the consequences never seem give them a moment’s pause.

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