Everything you need to know about negative gearing

Jake: With the election campaign in full swing, it seems one of the most heated talking points is negative gearing. It's a topic that has many divided and far more utterly confused, myself included. So I caught up with Adam Smith, finder.com.au's Home Loans Editor, to talk about the Australian property market.

Adam: Hey, Jake.

Jake: Adam, good to see you.

Adam: How you going there?

Jake: So what is negative gearing? What is this talking point even about?

Adam: Negative gearing, basically, is a tax minimisation strategy that allows you to write off any losses you have on an investment on your personal income, okay? So say you own a property, and the amount that it brings in rent is less than the amount that it cost to pay the mortgage on it and to do all the maintenance, right? So, at the end of the year, you're making a loss on it. That means you negatively gear. So you can take that amount that you're losing, and you can write that amount off of your personal income when you're filing your taxes.

Jake: Why would you want to make a loss on an investment as big as a property?

Adam: Okay, the thing with that is that property as an asset class, right, it's a long-term kind of investment, okay? So what negative gearing does is it allows you to offset those short-term cash flow losses in order to see a long-term capital gain. So, hopefully, from the time you buy your property to the time you sell your property, it's increased in value significantly, right? In between those times, when you may not be making money on it, you might be losing a certain amount of money, you're able to offset that cash flow loss by deducting against your income with the idea that one day you're going to sell this thing, and you're gonna make a lot of money on it, right?

Let's say you've got a $400,000 home loan, okay? And you're paying 4 and a half percent interest only. You're not paying anything on the principle. You're just paying interest, okay? Now, you rent that place out for $400 a week. Okay, so, 400 times 52: $20,800, okay? Now, meanwhile, your home loan repayments over the course of the year amount to $18,000, okay? Then let's say on average strata costs, maintenance, things like that: $2,000. So far you're doing pretty well. Your outlay is $20,000. Your income is $20,800. So your cash flow position is positive $800, okay? But right now you're not negatively geared, okay? So now we add on depreciation. So for depreciation, the depreciation allowance on a property of that price would be $4,000. So you take that $4,000 off, and all of a sudden, you're $3,200 negatively geared, but you've still got an extra $800 in your pocket at the end of the year.

Jake: Right. Okay. We kind of hear a lot about, you know, the cashed up investor alongside negatively geared scenarios. Is that always the case or...?

Adam: Well, see, this one's a bit difficult to figure out, because we do. We hear oftentimes that negative gearing is something that really wealthy investors use. But the data actually tells us that 67% of people who are negatively geared have a taxable income below $80,000 per year.

Jake: Really?

Adam: Yeah, but here's the tricky bit in that, is the numbers can be a bit misleading, because that's $80,000 taxable income. So that after they've already deducted whatever they're going to deduct for negative gearing, okay? So suppose I'm bringing home $120,000 a year, which would put me in one of the upper income brackets, but I'm negatively geared for $40,001. And all of a sudden, you deduct that, and I fall into that below $80,000 a year tax bracket. And it also doesn't take into account, suppose you have a couple who has, between the two of them, a combined income that puts them in the kind of upper levels of socioeconomic class, but only one of them is negatively gearing on their taxes, right? All of a sudden, when we hear the figures, they're in that 80,000 and below bracket. But in reality, the picture may be very, very different. So it's hard to really know, because the numbers can be a little bit deceptive.

Jake: Okay, so I get that. It makes sense for investors.

Adam: Sure.

Jake: In terms of looking at negative gearing within the wider sort of property market, are there benefits for either potential homebuyers or renters?

Adam: Well, there's definitely a benefit for renters, in that if you make property more attractive to invest in, then you get more people investing in that who would otherwise maybe put their money somewhere else, like say shares, or term deposits, or something like that. And if they're buying investment properties, that means that there are more properties on the market to rent. So supply goes up, and if supply outweighs demand, then, of course, prices come down. So when you make property an attractive asset class to invest in, there's more supply of rental properties, and that keeps rents lower.

Jake: So negative gearing actually can put a lid on rental prices.

Adam: It certainly can. Yeah. At least that's the theory. But the thing to remember here is that what's being proposed by the Labor Party is not to axe negative gearing all together, right? What they're proposing is to restrict it to newly constructed properties. So we hear all the time that if you get rid of negative gearing, then rents are going to skyrocket, because people aren't going to invest in property anymore, right?

Jake: Right.

Adam: What the labor party is arguing is that all those investors who were buying existing properties, because they can't negatively gear those existing properties, they're going to instead invest in newly built properties. And so if the demand for newly built properties increases, then we've got more properties being built, which is bringing more supply on the market. So they would say that that takes care of that whole problem of rental prices going up, because we've got more properties. The supply is still there, and it's outweighing the demand, keeping prices low. And the other thing that they would say is if I'm a first homebuyer, okay, every first homebuyer who enters the market takes one renter out of the market, because I was renting, but now I'm an owner-occupier, right? So what they would say is that if you take investors out of the market for existing homes, it makes it easier for first homebuyers to get in, okay? And, once again, the demand and the supply for rent evens out, because every time a first homebuyer is able to get into the market, the demand for rental properties falls by one.

Jake: So if it turns potential buyers into buyers, and it can keep a lid on property prices, what are some of the downsides to what's being proposed?

Adam: Okay, so I guess the downsides would be just like taking investors out of the market for existing houses would limit the competition first homebuyers face there, putting them into the market for newly built houses, all of a sudden, ramps up that competition. And those newly built houses, a lot of the times, are kind of in the suburban areas of the city, and they're far more affordable than these intercity existing properties. So, by and large, they tend to be good properties for first homebuyers. But if you've got a lot of investors that that's the only kind of property that you can invest in, then, all of a sudden, you've got first homebuyers competing for those properties with investors who are likely to have a lot more cash on hand.

There's a lot of fear around the idea of changing or removing negative gearing, and perception often becomes reality. Okay, so if you've got a bunch of property investors, and they're feeling nervous about changes to negative gearing, it's possible that they decide to sit tight and put their money in a different asset class. And all of a sudden, that perception kind of begins to become reality. It's they're nervous about it, and, therefore, it's kind of a self-fulfilling prophecy, and the property market suffers as a result of those kind of nerves that property investors are feeling about the changes.

Jake: Right. So we accidentally got a bit philosophical, but it is a case of this being all potential changes and a bit of hysteria at the moment could actually have some sort of impact.

Adam: Yeah, but that's the thing, I guess, to remember, is that all of this is speculative, right? At the end of the day, we really don't know for sure the impact, you know. So you can have all kinds of predictions, and prognostication, and everything, but at the end of the day, until something actually happens, it's all purely speculative.

Jake: Sure. Okay. Well, dude, thank you for the chat. It's definitely opened my eyes a bit.

Adam: Yeah, it's a confusing issue, and it's one that definitely inspires a lot of passion for people.

Jake: Cool.

Adam: Cool.