Community benefits of negative gearing

If we acted logically, would we ever eat food that’s not good for us? No. Would we ever skip our exercise?  No. Would we drink and drive? No. None of these are logical, but it still doesn't stop us.  

​Emotion gets involved.

As for the current debate attacking incentives to invest, well that is not logical either. Emotion has gotten involved.  Take negative gearing for example.  It's hardly a loophole for the wealthy, about three quarters of those who benefit earn less than $80,000 per annum. Also, we seem so consumed by our sense of current entitlement, we have forgotten the long-term benefits to government revenue by providing an incentive to invest.

Consider this scenario.

Bill and Mary are 50 years old. They earn $80,000 a year each and have just paid off their house. They know there’s unlikely to be much of a pension during their retirement.  They think sharemarket investing is gambling.  They don’t trust super because the rules always change.  That leaves property.

They bite the bullet and borrow $450,000 at 5%, secured by a mortgage over their existing home, to buy a property for $450,000. Repayments of $3560 a month will have the property paid off in 15 years when they want to retire. In Year One, the net income from the property will be $18,000, and the interest for the first year on their loan will be $22,500. Hence they are negatively geared to the tune of $4,500 and should qualify for a tax refund of around $1,250 each when depreciation allowances are taken into account. The total cost to the taxpayer is just $2,500 – hardly the stuff of grand tax schemes.

Now fast forward to Year Five, when their net rents are likely to have increased to $21,000, while their loan is down to $339,000. Their interest deduction for the year is just $16,950. They are now positively geared – no more tax refunds, they now get tax bills.

By the time Bill and Mary get to 65, the debt should be paid off and the property could be worth $670,000, assuming capital growth of 4% per annum. It would be producing rents of $24,000 per annum assuming annual increases of 3%.

End result:

• Tax paid from the last 10 years of ownership will far outweigh the tax refunds from the first 5 years.
• If they sell the property, half of the net capital growth of the property has to be declared as income. 
• The property will reduce the amount of pension Bill and Mary will receive. With their super, they’d probably not qualify at all (the age pension for a couple is a bit over $30,000 per annum).

So, for the initial cost of about $10,000 of refunds, the benefits to the Australian taxpayer are many, many times that in additional tax and reduced pensions.

There are other sides to the argument, like inflated house prices.  I’d love to hear people’s point of view.

Disclaimer
This article and opinion is based on generally available information and is not intended to provide you with specific financial advice or take into account your objectives, financial situation or needs. You should consider obtaining financial, tax or accounting advice on whether this information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. See full Terms and Conditions here.