The Power of Negative Gearing

Posted by Daniel Joseph

In this week’s article we will be delving into a particular facet of the Australian taxation system.

For most (if not all) Australians, the mere mention of tax is enough to leave an unsavoury taste in the mouth. It’s satisfying to know, therefore, that tax laws favour property investment. We are, of course, referring to negative gearing. Negative gearing by property investors reduced personal income tax revenue in Australia by $600 million in the 2001-02 tax year, $3.9 billion in 2004-05 and $13.2 billion in 2010-11. In its most simplistic form, negative gearing allows you to offset losses from property investment (in particular the differential between rental income and interest on debt) against taxable income, thereby reducing your tax obligations. Losses are deductible in the financial year they are incurred, providing nearly immediate benefit.

Most of you reading this would be aware that in July 1985 the Hawke government quarantined negative gearing interest expenses, so interest could only be claimed against rental income and not other income. What is perhaps less well known is that Hawke introduced negative gearing only six months prior. Previous to this, the Income Tax Assessment Act 1936 (As Amended) had quarantined all property losses from deduction against income from personal exertion (other business or salary and wage income). Any losses incurred in any one year would be accumulated on a register and would only be allowed as a deduction from income from property in succeeding years.

On its introduction, negative gearing legislation resulted in a significant spur in investor enthusiasm, which was subsequently dampened on its reversal only months later. After intense lobbying by the property industry, the government restored the old rules in September 1987, once again permitting the deduction of interest and other rental property costs from other income sources.

Given that negative gearing provides a benefit to investors, we look at the impact these changes had on the rental market over the two-year period. According to the rental component of CPI data, rents across the capital cities rose by 21.8 per cent over the two years to September 1987 (the period during which negative gearing laws were changed). The increase in rents was most pronounced over the period in Sydney (26.1 per cent) and Perth (31.1 per cent). As a comparison, over the two years to September 1985 rental costs rose by a lower 17 per cent.

Anyone who buys a property purely for the negative gearing benefits is investing for the wrong reasons. Of greater importance is purchasing the right property. At Blue Wealth, we help our clients make informed decisions that take into account the tax advantages of negative gearing. This approach to property investment ensures that our clients take as much of the emotion as possible out of the investment process, thereby paving the way for objective analysis.

Posted by Daniel Joseph, on 1st Apr 2014