If you’re new to property investing, then negative gearing might be a new concept to you. But it’s actually very simple. It’s just property jargon for your property costing more than it earns.
Let’s use an example. When you buy property for investment purposes, your income from that property will be the rent you receive.
When you rent out that property it would be ideal to have the weekly rent pay off your monthly mortgage repayments. If this is the case, then your property is positively geared.
But if the rent along with capital of your own is used to pay off that mortgage, then your property is negative geared.
It seems obvious that no one would want to have a negatively geared property, right? Why put money into your investment when it couldn’t pay itself off?
Yet there are advantages to negative gearing.
A lot of the time people talk about the tax benefits of negative gearing. As in your investment property costs you more than it earns, so you can apply to deduct those losses. And most people opt to reduce their taxable income. This means that they are now paying less tax on their wages.
This is not a sustainable model for making money. Why would you want pay $1 to get 40 cents back? But in the early stages of property investing it could be beneficial for first time property investors.
The money received from tax deductions could go a long way in saving up for that second deposit. And there has been lots of talk recently about negative gearing and whether it should be reformed.
But the way I see it, it’s unlikely that negative gearing will fall to the wayside.
Australia and Aussie banks are already too heavily invested in property. It would be ridiculous to make it harder for property investors to enter the market.
But yesterday the Prime Minister, Malcolm Turnbull wrote a detailed blog post reaffirming why negative gearing should stay as is. He argued that changing the current tax system would be undesirable for a whole bunch of reasons.
Firstly Turnbull argued that negative gearing is a generally accepted principle. It allows property investors to offset losses against gains. And even though you would prefer to have a positively geared home, why not claim some money back if you’re making losses?
Second, Turnbull points out that you can reduce your tax discount of up to 40%, recommended by Australian Future Tax System (AFTS). And lowering this discount amount would hurt existing property investors. It could even deter future potential investors as well.
But let’s not be fooled. Turnbull’s blog post is intended to drum up support for the Liberal party. But so far he’s made some good points for why negative gearing should remain as is.
Running with Turnbull’s idea, if changes are made to the current tax system, it could mean less than desirable implications for our housing market. If negative gearing is tossed in the bin or changed, then property investing could be grossly unattractive.
And this would be especially true for first time property investors.
First time property investors usually don’t have a strong cash flow to service a mortgage for the first few years. However as their career progresses and they move up the organisational chain, their salary increases and along with it their ability to service loans.
Therefore negative gearing could be a huge advantage for these first time property investors. If there is no encouragement to invest in property, then they will quickly look for other investment avenues. The deductions at the start could go a long way in helping them to accumulate more capital for that second investment.
This then might create a barrier for those new to property. If the incentives aren’t there, then how do you expect anyone to invest?
Thirdly Turnbull believe if any changes were to happen, those changes could be unfair. He refers to the middle to low income earners who might be unable to borrow and invest. And if negative gearing is dead and gone, this could well be true.
As I explained above, first time property investors will be discouraged the most. They’re usually the lowest income earners and would be hit hardest by a lower tax discount.
Finally, Turnbull voices his concerns that removing negative gearing would increase the effective income tax rate for wage and salary earners. This could, Turnbull believes, reduce the incentive to work.
Junior Analyst, Money Morning
PS: When investing in property it’s usually about the long game. It’s a steady process, and anyone thinking of investing needs to have a well thought out plan. That’s why you can’t just buy a few properties and call it a day. Most property investment plans are expected to last decades.
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