The rundown on negative gearing

Negative gearing may be framed in ‘negative’ terms, it often adds up as a positive for investors in many cases. Here’s the rundown.

This is a topic often explored by property experts, talked about in the news, and increasingly, tread all over in Parliament.

However, like anything that becomes a matter of political football, along the way, the topic of negative gearing has become a little misunderstood. It’s no wonder that investors may struggle to understand the simple fact that negative gearing is often a positive.

In property or shares, gearing simply means borrowing to invest. When an investment property is negatively geared, it means the investor is receiving a rental return less than their property expenses. When the property is positively geared, it means the opposite.

It may seem strange on the surface, but unlike other losses, this ‘loss’ isn’t as material as it may seem. In a twist, courtesy of the Australian Tax Office, negative gearing losses can be used to offset other taxable income and reduce the amount of tax owed.

The beauty of negative gearing really comes into clear view in a property bull market, which Australia has been experiencing since the 1990s. This multi-decade bull run has led many investors to anticipate a capital gain when they finally come to sell their property.

The threshold where negative gearing becomes worthwhile depends on several things. By and large, negative gearing is a worthwhile strategy for investors earning an income that places them in higher tax brackets. These investors benefit more from offsetting any loss incurred on rental income. In addition, investors should ensure they have enough protection, in terms of savings or income, to incur ongoing losses when negative gearing. Interest rates become another important factor, to the success of a negative gearing strategy.

Above all though, negative gearing is worthwhile if the property is sold at a profit, which is classed as a capital gain. Investors who employ this strategy can limit their losses on their asset until it comes time to sell — and then receive a 50 per cent capital gains tax discount if they hold the asset for more than 12 months.

Proposed changes for negative gearing

The Australian Labor Party, spearheaded by Bill Shorten and Chris Bowen, plans to limit negative gearing if they are elected at the Federal level in May. Labor’s proposed changes are perceived as unfair by many property owners who have reaped the benefits of negative gearing over the years.

Labor designed its proposal in effort to ground a skyrocketing market. This would relieve some of the intergenerational pressures our nation is facing, Labor argued, where taxes favour wealthier older Australians who own their homes.

But, efforts to restrict a negative gearing scheme of a different ilk in the 1980s dramatically and detrimentally affected the property market. Critics of Labor’s proposed changes are worried history could repeat.

Labor proposes to change the capital gains tax discount so tax is paid on 75% of capital gains for most assets, effectively making many new investors worse off.

And yet, the housing market has cooled anyway, falling more than 10% from its 2017 highs. The banks first ‘tightened up’ lending and we had regulators hoping to engineer a ‘soft landing’ for the Australian property market. Throw the Banking Royal Commission into the mix, where financial services have come under closer scrutiny, among other macroeconomic pressures, and the housing market is bound to become materially affected.

Alternative opportunities for investors

From regional Australia to tightly held blue-chip pockets, the falls have been across the board. It’s not doom and gloom, it’s just getting harder for a retail investor to cherry-pick even a postcode, let alone an individual property. In times like these, an expert opinion can become worth its weight in gold.

If direct property ownership becomes unfavourable due to policy changes, investors may however find it’s more worthwhile going through a managed investment such as a mortgage trust, like the Trilogy Monthly Income Trust, which can assist individual investors in achieving a level of diversification that would be difficult to achieve on their own, all whilst achieving an attractive return from the Australian property market.

Gain further insight into investing in the Australian property market by checking out the latest edition of Angle Magazine.