Negative gearing: An easy guide to how it works and how it might change under Labor

'Gearing' is when you borrow money to invest. Source: Getty.

You may have seen the term ‘negative gearing’ in the news a lot recently, as the major political parties begin to tout their policy proposals in the lead-up to May’s federal election. But what is negative gearing, and how might you be affected if the current system is overhauled by a future Labor government?

Gearing is when you borrow money to invest, and the term is commonly used in relation to investment properties. The income earned from this investment is usually described as being negatively or positively geared.

Opposition Leader Bill Shorten says that the current tax subsidies offered to Australians with negatively geared properties are costing the federal government millions of dollars in potential revenue each year.

As a result, the ALP has pledged to overhaul the system as part of a wider series of tax reforms, which will also see the removal of cash refunds for excess franking credits, if Labor are elected later this year.

What is negative gearing?

A property is deemed as negatively geared when the rental return is less than the cost incurred for interest repayments and outgoings such as expenditure on maintenance.

This happens when investors make an investment, most commonly in property, which results in a financial loss in the short term but it expected to make capital gains in the future.

For example, if you bought a unit as investment property and the expenses for the property (interest on mortgage repayments, upkeep etc) were greater than the money received through rent, resulting in a $10,000 loss, current Australia tax rules mean you could use that $10,000 loss to reduce your level of overall taxable income, therefore lowering the amount of tax you would be required to pay.

According to Australian tax law, you may be able to claim the interest portion of your loan repayments and also some other costs as an expense, providing the property is available to be rented.

What is positive gearing?

A property is positively geared when the amount of rent you receive from your tenants comes in higher than the cost of your interest repayments and outgoings.

What does Labor propose?

If Labor leader Bill Shorten becomes the next prime minister, his party has vowed to reform the current negative gearing and the capital gains discount, which they claim will help “put the Australian dream of home ownership back within the reach of middle and working class families”.

(The capital gains discount refers to another tax rule that says taxpayers are entitled to a 50 percent discount on the capital gain they make when selling an asset, as long as they held the asset for more than a year before the sale – effectively reducing the amount on which they must pay capital gains tax (CGT). If not held for a year, the taxpayer would be required to pay CGT at their marginal tax rate on the entire profit made from the sale of an asset, such as a property. Property investors use the CGT break to cut the tax payable on the sale of investment properties by ensuring they hold a property for more than a year prior to sale.)

According to the policy outline on the ALP’s website, negative gearing and the discount for capital gains have not achieved the aim of boosting housing supply in Australia, despite costing the budget more than is spent on higher education or child care.

As PM, Shorten would seek to refine what he describes as “unsustainable and unaffordable” tax subsidies, claiming they benefit only the wealthiest Aussies, to deliver a “fair tax system” and a $32 billion boost to the budget.

“Labor will limit negative gearing to new housing from a yet-to-be-determined date after the next election,” its proposal reads. “All investments made before this date will not be affected by this change and will be fully grandfathered.

“This will mean that taxpayers will continue to be able to deduct net rental losses against their wage income, providing the losses come from newly constructed housing.

“From a yet-to-be-determined date after the next election losses from new investments in shares and existing properties can still be used to offset investment income tax liabilities. These losses can also continue to be carried forward to offset the final capital gain on the investment.”

In effect, investors will not be able to use, for example, a negatively geared property to reduce their overall tax bill, only the tax payable on any investment income they may receive or they can use the losses to offset the CGT that would be owed on the full gain made on the sale of an asset. It removes the ‘two bites of the cherry’ investors currently have under the current rules and, for those whose income is not primarily derived from investments, reduces the attractiveness of negative gearing.

What has the government said?

It should come as no surprise that Labor and the Coalition differ in their views on taxation, with the two major parties regularly locking horns over the matter.

Speaking in 2018, Treasurer Josh Frydenberg described Labor’s negative gearing policy as “a risk to our prosperity”, claiming that the majority of people who negatively geared properties had a taxable income of less than $80,000 per year.

“Those who use negative gearing are not necessarily rich nor the owners of multiple investment properties,” he said. “Rather, they are made up of 58,000 teachers, 41,000 nurses, 19,000 police and emergency personnel, and many other tradies and small business people who put aside a bit each month to save for their future.”

He also claimed that, as house prices continue to fall, Australia couldn’t afford Labor’s new tax, adding: “Labor’s big new property tax will hurt homeowners, renters and investors and threaten our economic prosperity”.

Do you have any negatively geared investment properties? What do you think of Labor’s proposed policy?

Important information: The information provided on this website is of a general nature and for information purposes only. It does not take into account your objectives, financial situation or needs. It is not financial product advice and must not be relied upon as such. Before making any financial decision you should determine whether the information is appropriate in terms of your particular circumstances and seek advice from an independent licensed financial services professional.

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