What will be the consequences if Negative Gearing is abolished in Australia?

Question

There has been recent speculation in the Australian media about the Government possibly abolishing Negative Gearing in Australia in order to shore up falling revenues. In fact certain interest groups have been pushing for the end of Negative Gearing on the basis that it is a major cause of poor housing affordability in Australia.

Firstly, how will the government increase revenues by abolishing Negative Gearing?

Secondly, is it true that Negative Gearing is one of the major causes of poor housing affordability in Australia?

And lastly (closely related to the second question), what would be the possible affects on the housing market in Australia if Negative Gearing was abolished?

Answer 1

Yes, there has been speculation in the Australian media for a while regarding Negative Gearing and whether it should be abolished or not. It is being pursued by various interest groups including Welfare Australia and Crikey. In fact it was actually abolished (temporarily) by treasurer Paul Keating in 1986. After house prices started falling and rents increasing it was reinstated again by Paul Keating in 1988. Most politicians are too worried about the voter backlash they will face if they do abolish NG. However, I agree with Jamie McIntyre that it will eventually have to be abolished, and I think this time for good or else future governments will struggle to pay for the needs of an aging population (including pensions and health needs).

What you have to understand however, if NG was abolished it does not mean that you cannot claim costs on your property against the rent you receive on it. For example, at the moment with NG, if your annual gross rent is $10,000 and your total costs including depreciation is say $15,000, then you can use the additional $5,000 in expenses against your other income and thus reduce the amount of tax you pay for that year (if your marginal tax rate was say 30% then you would pay $5,000 x 0.30 = $1,500 less in tax for that year). If instead NG was abolished, your income from the rental would be zero (as you would deduct $10,000 of your expenses from the $10,000 gross rent), and the remaining $5,000 in expenses you would carry over to when you start actually making a positive income from your rent. If you sell the property before you start making positive income, then your carryover expenses would be added to your cost base and reduce the capital gains tax you have to pay.

This could make shorter term speculation in property less favourable and many novice investors who don't really understand the concept of NG (and are only allured into property investing with NG due to advice from their accountant, their friends and property spruikers) may be deterred from investing in properties in the future. Also some might see that their benefits of owning an investment property may diminish, and will ask: why should I keep this property if I have to put money in it every month but don't get any tax benefits anymore? These people may end up selling their investment properties. Thus you will have less demand on investment properties and a greater supply of properties on the market. This will definitely lead to a drop in property prices, for the short to medium term anyway. I think once people start to learn about other strategies regarding investment properties (that don't rely on NG), then demand and prices will pick up again.

Rents may go up initially (especially in low vacancy areas), as less properties will be available for rent, thus higher demand with low supply. But once again I think this will be for the short to medium term, as the higher yields (lower prices and higher rents) will be attractive to investors preferring positive geared properties. And once the spruikers come up with new strategies and marketing material to attract the novice investor, you will get demand and prices for properties increasing again and rents stabilising over time.

Answer 2

Firstly, how will the government increase revenues by abolishing Negative Gearing?

Negative gearing is deductible against current income. Abolishing it will defer the deduction to the sale, where the profits are taxed at a discounted capital gains rate (50% discount if held over a year). Assuming the investments will remain at the same rate, the government will be able to collect more current taxes and give out a discount on more gains in the future (i.e.: investors will lose current full rate tax benefits and gain future discount rate tax benefits). This will definitely make negative cash flow less attractive.

Secondly, is it true that Negative Gearing is one of the major causes of poor housing affordability in Australia?

It is likely to only be one of many reasons.

And lastly (closely related to the second question), what would be the possible affects on the housing market in Australia if Negative Gearing was abolished?

That's a very speculative question. Investors lose current tax benefit and some of the overall tax benefits (the losses reduce capital gains which are taxed less), but overall the investors can still make profit.

Here's what I think about it (I'm in no way a real-estate professional or economist, but I do have real-estate investments). Here, in the US, we have a stripped down version of negative gearing for rental properties - its called "rental real estate activity passive losses", and investors can deduct losses against current income, but up to a certain limit, with phase-out at high income levels. I don't see this affecting real-estate market significantly, people still invest in rentals quite profitably. In the short term it might affect the market (and some people claim that this effect may be too painful), but in the long term I'm guessing it will stabilize.