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When the expenses associated with an investment are higher than the income that it generated in a year, negative gearing entitles the asset owner to a tax deduction on their other forms of income.
Most people associate negative gearing with property assets, but it can include other types of investments, such as shares.
It is consistent with the way Australia’s tax system operates more broadly in that people pay tax on their personal income after expenses have been deducted, just as businesses pay tax on their profits, not the gross revenue. Negative gearing recognises that some people face higher costs than others when producing an income.
History of Negative Gearing
Negative gearing has existed in Australia since at least the 1930s when it appeared in the Income Tax Assessment Act of 1936. Over the years, various governments have made attempts to abolish it, but each time the backlash has been swift and severe from voters and it remains in place today.
Australia is one of the few countries in the world with a negative gearing scheme. Many critics argue that negative gearing as a tax break has driven up prices, although its impact on housing affordability is disputed by some. Others claim that supply and demand is a more significant driver.
“There’s an argument to suggest that negative gearing does reduce rental prices, because an investor may think, ‘Well, at least I’m negatively geared—I’m getting a tax deduction, so I won’t increase the rent for my tenant,” explains Michael Sauer, Certified Financial Planner and Advisor at Endorphin Wealth Management.
“However, investors in other countries don’t get the ‘free lunch’ that is negative gearing.”
And those who do not support negative gearing see the situation very differently, as he explains.
“We have seen over the last 12 months as inflation and interest rates have gone up quickly that landlords have been very happy to raise rents. So I’m not sure that the argument that it protects tenants stands up.”
How Negative Gearing Works
If an investment property were to generate $10,000 a year in rent, but the expenses associated with it (such as agent fees, mortgage interest and maintenance bills) total $15,000, it leaves a shortfall of $5,000.
If the property owner’s income is $100,000, he or she can deduct the $5000 from their taxable income and thus reduce it to $95,000. That means paying less income tax and keeping more of their earnings in their pocket.
Pros of Negative Gearing
Simply put: negative gearing enables an individual to reduce the amount of tax paid.
“It also allows you to more easily use the bank’s money to grow your wealth over time,” says Sauer. “That is to say, if you take a 5% principal and interest loan, but the property’s combined capital growth and income is generating 10%, then you’re essentially using the bank’s money to obtain that differential.”
Cons of Negative Gearing
For someone such as a retiree or unemployed person who is in a low or zero tax rate and whose investment is not growing fast enough from a capital perspective, negative gearing produces no benefit.
It is important to remember that negative gearing allows investors to recoup some of the costs associated with their investment as a tax saving, but the tax refund may not come for a year or more. Investors therefore need cash to fund the negative gearing.
Investors who use this strategy need to be confident that their asset will deliver capital growth in the long term when the property is sold. In that way, the losses will only be temporary.
Another con is that negative gearing reduces the amount of public funds that the government has at its disposal to use on projects that benefit the broader community. Others also believe that negative gearing unfairly privileges the investor property class, thereby making housing even more unaffordable for first home buyers.
Why Is Negative Gearing Controversial?
Negative gearing is controversial because although it enables more people to acquire an investment property, it overwhelmingly benefits the wealthy. The tax concessions for property investors will cost the budget more than $20 billion annually within a decade, according to a new report by the parliamentary budget office (PBO). In 2021-22 the amount of lost tax revenue from negative gearing and capital gains tax concessions was $8.5 billion.
In the 2016 election campaign, then Labor leader Bill Shorten toyed with removing it (although he did not wish to apply it retrospectively). The ambitious reform policy is thought to have been a chief reason for his party losing the election. It is unlikely that other governments will touch it in the near future.
Sauer believes that negative gearing is more likely to be abolished if the national budget is producing a deficit, because the government would need to obtain as many sources of tax revenue as possible.
“When Australia was in surplus, it was possible to manage the books along with everything else. But if we’re in more and more deficit and the budget gets worse, which may be the case after the COVID-19 pandemic, then negative gearing could become a low hanging fruit that the government seeks to remove.”
Frequently Asked Questions (FAQs)
Is it better to negative gear or positive gear your property?
Positive gearing is less risky than negative gearing, because the returns are more predictable and income is consistent.
How do you make money from negative gearing?
Money can be made in the long term if the property or asset increases in value when it is sold.
Who benefits from negative gearing?
Most of the benefits derived from negative gearing goes to high income households, according to research by the Australia Institute. It found that approximately 50% of the benefits go to the top 20% of households, while the bottom 20% only receive 6% of the benefit.
How much can I save on taxes with negative gearing?
It will depend on how much the loss is that offsets the rest of your income tax liabilities. Check an online calculator and speak to your accountant.
What is positive gearing?
Positive gearing involves receiving more in rental income than what you needed to pay in expenses, such as loan repayments and property maintenance. Positive gearing is more common when rents are high due to strong demand for rental property and interest rates are low.
