'Negative gearing' is a buzz-term amid the current federal election campaign, but although widely deployed around Australia, the truth is that this investment mechanism is, at best, misunderstood.
So with the related debate about capital gains tax also raging amid the thick soup of federal politics, let's take a look at what all the fuss is about and try to separate some fact from fiction.
What is negative gearing?
Firstly, let's define our terms. Negative gearing is when an investor borrows money when buying an investment property but initially makes a loss, expecting to cash in on the capital gain later on. For example, the rental income from the investment property is less than the mortgage repayments and ongoing costs of the property. But the immediate benefit of negative gearing in Australia has been the tax benefit, with the losses completely tax-deductible against the investor's taxable income.
So why all the fuss in the 2016 federal election campaign?
Because the ALP is proposing to 'reform' negative gearing in Australia, and halve the existing capital gains tax discounts.
Labor argues that negative gearing is unfair because it is predominantly used by high income Australians to minimise their tax and then benefit even more through the capital gains discount, with the low and middle income earners concentrating simply on the rising cost of living. 'Ultimately, a dollar of tax avoided by high income Australians is an extra dollar of tax paid by all other Australians,' the ALP argues on its website. Labor's plan is that only new properties will be negatively geared.
But the Coalition insists that some of those lower and middle-income earners - 'Mum and Dad investors' - are actually among the people who are benefiting the most from negative gearing, while the Greens say leaving the provisions alone means investors maintain the upper-hand versus first home buyers struggling with affordability and the diminishing dream of getting the right home loan and home ownership.
How will changes to negative gearing affect real estate?
One argument is that pushing investors into new property will increase supply, therefore improving housing affordability. There are figures to back this too, which show that less than 10% of all negatively-geared properties in Australia at the moment are new homes.
But those in favour of negative gearing think getting rid of it will only hurt an already suffering real estate market. Data released by the Australian Taxation Office shows that while wealthier investors will be able to shift their investments to new property or offset tax against other investments, the arrangements of 'Mum and Dad' investors may not be as flexible as they typically only offset wages.
So if negative gearing does benefit the lower earners, it makes sense that taking away that benefit will hit them harder than it hits those who are already wealthy.
And what about house prices? Negative gearing's critics argue that at the moment prices are constantly being pushed up as struggling first home-buyers compete against wealthy investors who can afford to bid more because they are already rich and stand to gain even more.
But a survey conducted by Western Australia's Real Estate Institute found that over half of the current population of property investors would consider selling up if negative gearing is scrapped, which could send rents skywards.
How to make an investment property positively geared
For some, the biggest cost of an investment property is the mortgage. Often strata fees and management agent costs can’t be reduced, whereas the interest rate of an investment property mortgage can be renegotiated or refinanced to help switch the investment property to be positively geared.
Improving the quality of the investment property can yield higher rental returns too. Adding additional accommodation or improving the fittings and fixtures can attract renters who are prepared to pay more. To learn more about what renters are looking for, read our article ‘The important features that tenants want’.