Tuesday, July 12, 2016 / Services
There has been widespread reporting on Negative Gearing lately, most likely due to the fact that is has been turned into an election issue.
We just wanted to take some time, to outline some of what makes Australian negative gearing systems unique, and in our opinion more fair than in many other countries.
Negative gearing allows a property investor to claim any losses incurred from their rental property against their total personal income for the year.
The losses can be a result of the property not generating enough rental income to cover the costs of holding the property.
Costs of holding the property can include, but are not limited to:
Australia is not unique in the way that we have set up our negative gearing policies, and they certainly are more intricate and complex than this simple explanation.
Most developed economies have systems and regulations in place for how property investors are able to claim the losses incurred from their investments. Some countries are similar to ours, and some are very different.
Providing the investor is not in a partnership, or operating as a trust, they are also able to claim any rental losses incurred from their investment property against their total income each year.
This system is considered to be very similar to our own systems of unrestricted negative gearing claims against personal income streams.
The Kiwi's have a very similar system in place to ourselves.
Like us, they also allow for an investor to claim their losses against their personal income in he same year.
However, it is interesting to note that they have provisions in place that require the rent of properties which returned a loss to be at market rate.
Whilst Canada does not in principal allow an investor to claim losses from their property against personal income, there appears to be complicated ways in which it can be done.
Essentially (from the limited resources we have found) it would seem that a Canadian can indeed claim losses on their rental property, as long as those losses are claimed against income that does not constitute a capital gain.
Essentially meaning that the negative geared property will eventually need to be positively geared in order to qualify for the claims. These claims can be made in the same year as the losses.
All in all however, a much more complicated system, which would require professional assistance to navigate.
The USA has some very strict policies in place regarding income streams and having each stream quarantined from the others.
What this means is that it is extremely difficult (albeit, some report it is very technically possible) for an investor to claim any of their rental losses against their personal income.
The UK has strict rules surrounding negative gearing and how any rental losses may be claimed.
An investor can not claim any losses from their investment property against any non-property related income.
Any negative gearing losses that are incurred, are either claimed against other property's profits (providing they have a portfolio larger than one property), or the losses are carried forward into the year in which their property does generate a profit.
This means that any losses made in holding the property, can never be claimed for in the same year, unless they are already making profits from other investment properties.
Like the UK, Germany has some very strict rules on claiming any losses incurred from holding investment property.
No losses may be claimed against the investor's personal income, only against other rental income.
The reality is, and we won't shy away from this, negative gearing is currently providing larger tax cuts to people who are already proactively building wealth than to other Australians.
Numerically, there are more Australians who are on incomes below $80,000 (lets call this Group A) that use Negative Gearing than Australians on incomes above $80,000 (lets call this group B).
Income less than $80,000
Income greater than $80,000
Data sourced from ABC Fact Check
This does show that proportionally an Australian on a higher income, are more than twice as likely to be accessing tax deductions from negative gearing. Even if there is numerically more people from Group A that are using negative gearing.
Now we haven't crunched the data exhaustively, and i depends on where you check, as official reports are hard to come by, but it seems that only around 10-20% of Australians actively engage the services of a financial planner.
From reading various reports and articles from the financial planning industry, we certainly can see that there are a great number of Australians who are not actively seeking professional assistance in managing their finances or planning for asset growth into the future.
Negative gearing allows for tax rebates on losses experienced from investing in the Real Estate market. Sometimes these losses are not by choice, and other times the investor goes into the transaction knowing that their investment will run at a loss for a set period of time, even up to a decade or two.
The main use of negative gearing is to allow the investor to make their investment, yet still have enough cash flow to go in with the rest of their life.
Often the existence of negative gearing can be the difference between an investment strategy being affordable, and simply being a pipe dream. Knowing that there is some space to receive some tax back allows the investor to enter into the arrangement with more confidence.
An Example of Negative Gearing in Action
If "Bob" wants to invest in property as a way of making sure that when he retires he can maintain the same level of comfort that he is used to during his working life, the he must be sure that he can afford the property in all circumstances.
For example, Bob may not always be able to guarantee that his property will be tenanted, as even the best property manager can not force tenants to not break a lease occasionally. This potentially leaves Bob with a few weeks in one year in which he does not have a tenant.
If the cost of holding the property is normally $400 per week, and the property is normally rented out at $400 per week, then in theory Bob's property is actually neutrally geared. He has not purposefully decided to negatively gear and then claim the tax benefits.
However, what Bob did not account for was that there would be 2 weeks that year in which he did not have a tenant in his property. This may be caused for a whole range of reasons, such as tenants losing employment, needing to move interstate or so on.
This 2 week period without rental income means that Bob end's up out of pocket by $800, and actually finding himself negatively geared on the property.
At the end of the financial year, Bob and his accountant know that they can claim this $800 loss from the property as a deduction on Bob's tax return, allowing him to receive a portion of his losses back on tax.
This allows for Bob to know that he has cash flow ready year after year, and that he does not need to keep putting more and more money into the property in order to maintain his investment.
But only because Bob lives in Australia. If Bob was living in many other countries in the world, he would not have been able to claim his rental shortfall against his yearly tax return, as his yearly tax is calculated against his income from working.
In the UK or the USA for example, Bob's losses would have to be covered by Bob in the year that they happen. He would still get to claim the losses later on down the track, but only once he sells the investment property. This eventual sale may be 10 years, or even more down the track however.
The definition of fair, is typically 'treating people equally without favouritism or discrimination'. This egalitarian attitude is a core component of what it is to be Australian.
When discussions of equality come around, the concept is frequently broken into two separate ideas.
Equality of Opportunity
Within this type of equality, the central goal is to ensure that each person within a society have equal access to resources and opportunities. However, it is still left up to them to access these opportunities and then progress.
This includes ideals such as equally accessible education for every member of society, regardless of race, sexuality, gender, religion, and so on.
The primary goal of equality of opportunity is to make sure that there are no systematic or structural limitations placed upon people that would stop them from accessing opportunities.
Equality of Outcome
Within this type of equality, the central goal is to ensure that each person has an equal outcome as all others. Within this ideology, every member of society should have the same level of wealth and economic ability.
This at times can be seen as a more pro-active ideology, with less philosophical pondering and a larger political motivation.
The major principle of this perception of equality, is that in order to be fair, there must be an equal division of resources across the whole population.
The Australian system of negative gearing provides for greater equality of opportunity for Australians who are looking to secure their financial futures, whilst at the same time it safeguards our society from moving even further from an equality of outcome.
The reality is that investing in property is one of the most proven and sure ways of generating wealth.
Our negative gearing laws allow for a greater amount of Australian's to access property investment than would otherwise be able to.
When it comes to cash-flow standing in the way of investing in property, we know that it is more likely to prevent someone who is earning a lower income than it is to prevent someone earning a larger income. People who have a larger income will always be able to sacrifice money this year, to ensure that there is wealth in years to come. This is not necessarily the case for a majority of Australians, who don't have the finances to be living decade to decade.
The principle role of our negative gearing is to claim against losses in the same year that they occur, not in 10, or 20 years time when the investment property is sold.