Is Negative Gearing Tax Dodging?

In the course of doing what I do, I review vast amounts of economic and investment information from all over the media – social, print & digital – in fact I invest several hours a day on this. I want to be the best investor I can be and sorting through the piles of opinion, fact and material is critical to having an understanding of what is happening in our financial world.

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Late last week, I read an interesting article from one of Australia’s most respected economists, Mr Saul Eslake. In it, he says “Negative gearing can’t be equated with standard business tax practice, and is not allowed in many countries.” Mr Eslake notes that in a speech published in 2005, our current Prime Minister Malcolm Turnbull, described “negative gearing as a form of ‘tax avoidance’, one of the few open to PAYE and other ‘unincorporated’ taxpayers.”

Mr Eslake goes on to say that people are allowed to change their minds, when the facts change. Indeed it seems our Prime Minister has done so. In a recent interview with the ABC’s Leigh Sales, Mr Turnbull defended negative gearing as “income tax 101”, going on to explain it as  “a fundamental principle of tax law and has been forever that you can deduct from your income the interest expense of money that is borrowed to purchase an income-producing asset”.

This Mr Turnbull agrees with that Mr Turnbull’s current view of negative gearing. While Mr Eslake follows on to say that the other Mr Turnbull “would do well to follow..…the inherent logic of his own opinions of a decade ago, rather than regurgitating the self-serving propaganda of parts of the property industry.”

I don’t understand much of Mr Eslake’s logic here. In the remainder of his article, it seems he is implying that anyone who utilizes the law and make a tax deduction claim as a result of owning an investment property that runs at a loss is a tax dodger. It has been well practiced over a long period of time that investment or business losses can be claimed as tax deductions – whether that be property, shares or business. Why should property be an exception?

Mr Eslake refers to measures introduced by popular centre-right governments of New Zealand and the UK to slow down property speculation.

New Zealand has no capital gains tax beyond the measure bought in to temper speculative investing, which is to pay tax on any gain made if the property is resold within two years of purchase – the idea being to encourage longer term investing. I think that would be great for Australia to adopt both that policy and removing stamp duties, which New Zealand doesn’t have either.

Mr Eslake refers to legislation coming in to force in the UK in 2017 which will end tax deductibility for losses incurred by landlords. The UK has lower rates of corporate and income taxes, so the benefit of tax deductions is not as steep there – again it would be grand if Australia could come in to line with other major economies and lower our rates of taxation, both corporate and personal.

And while the US doesn’t allow deductions for losses on investment properties, my understanding is that it allows deductions on owner-occupied home loan interest – this means many people keep buying bigger & bigger homes to live in. This probably has a much larger effect on how people choose to invest in housing than having that tax benefit for investment properties, which become rental housing for those who cannot own – and the government doesn’t have to provide public housing for them.

Investors who use the tax laws to help them own investment property for several years while the rents catch up with the payments are wise and looking to their future. It is not so important as in other countries such as the US as the rental yields are generally higher since their capital cost of buying real estate is much lower. Much of the real estate you buy there can pay for itself, just from rental returns, so needing a tax break is not so imperative as most US based investors expect to achieve positive cashflow from day one.

An investor should never ever, ever buy an investment property simply because he or she could claim a tax deduction. The first and primary reason to invest in real estate is for capital gain, the second for income. Tax benefits should be a distant third on the reasons to invest.

I submit that most people won’t be able to accumulate enough money in a superannuation fund to provide for a comfortable living after a lifetime of work. In fact I wrote about it a few weeks ago in an article entitled “Is $1 Million Enough To Retire on?”. So if super isn’t enough, why shouldn’t the government encourage people to invest for their future and have these same investors provide rental property so government doesn’t have to provide public housing? And if the investors are successful over time, they likely won’t have a need to draw on the public purse to receive the pittance (pension.)

I also read in several articles that the amount of deductions for negative gearing has been declining over several years, mainly due to lower interest rates. But bottom line, a property bought today and negatively geared will likely become positively geared in just a few years as rents rise. And that would end that tax deduction for the investor.

I am a bit tired of all the negative commentary and finger-pointing at people who are trying to grow their wealth, as anyone in this the lucky country has an opportunity to do, if they so wish.

Negative geared investors are not tax dodgers and should not be vilified for using the law to provide for their future. In fact, I think they should be celebrated.

Don’t you?

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  • Chris Gunn

    You are correct in that the US does not have negative gearing for investment properties but permits deduction for own home mortgage. There is also section 8 housing. An investor who owns a section 8 property will receive below market rent from the tenant (low income person) but the remaining rent to bring the rent to normal rent for that market is paid by Government. The main disadvantage with a section 8 property is that it is difficult for the owner to get it removed from the section 8 scheme (usually by sale to an owner occupier). If the property is to change ownership from investor to investor, the property remains in the section 8 scheme.
    Section 8 properties are usually in areas that are perceived to have higher crime rates. The properties themselves very often require much higher levels of ongoing maintenance. Few tenants “do the right thing.”