If the great Australian dream is the purchase of your very own home, then the ability to negatively gear investment properties is an Australian institution. What will become of the Australian way if the Labor party is brave enough to challenge this iconic status quo?
Anyone who tunes into political commentary will be subjected to the notion that purchasing investment properties with the assistance of negative gearing is predominantly within the realms of the wealthy. I can tell you in over 20 years of practice I have seen many cases of clients on modest incomes invest in their future through the purchase of investment properties; they even manage to save tax along the way using negative gearing.
Let’s start at the beginning. Just what is negative gearing?
Negative gearing is when a taxpayer purchases an investment property and the tax-deductible costs exceed the rental income, meaning it makes a loss. This loss is then offset against a taxpayer’s other income such as salary and wages resulting in a reduction of their overall tax burden.
The obvious question is why anybody would invest in something that makes a loss. The answer is in the end game; the objective is to hold the property for the long term, choosing a point to sell it at a profit and then use the funds for retirement purposes or paying off the mortgage on their home.
This is where Labor looks to upset the apple cart. If it wins the next election, Labor proposes to limit negative gearing associated with investment properties to newly constructed housing believing that this will help housing affordability, in particular for first home buyers.
However, from a capital city perspective, newly constructed homes are generally in outer lying suburbs – typically first home owner territory. Which means that under Labor’s proposal, investors seeking to invest in their future through negative gearing will be competing directly with first home buyers. This may serve to inadvertently increase prices for new homes.
At the outset, those with existing investment properties needn’t worry, at this stage, Labor has indicated that existing properties will be grandfathered and the proposed new rules will not apply to them. However, on further analysis, it raises other issues which will need to be addressed. What happens if the investment property loan is refinanced or there are significant capital improvements made to an existing property with the use of borrowed funds.
Investment properties aren’t the only investment a taxpayer can fund through negative gearing, those with share portfolios will also be in the firing line if they use borrowed funds to purchase their portfolios. These taxpayers will be able to offset any net investment loss against all other investment income; however, any excess will have to be carried forward and, it appears, added to the cost base of the asset. The practical application of this will be interesting to observe with those taxpayers who have multiple investment properties or mixed investment portfolios.
Labor hasn’t provided any great detail of its proposed policy and until the election is decided we simply don’t know what we will be dealing with. Also of interest will be if the Liberal Coalition decides to make any similar changes in the soon to be announced Federal Budget. One thing that is certain – we are in for interesting times ahead.
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