Sections below with a light blue background are excerpts from an Australian Labor Party publication entitled Positive plan to help housing affordability
Negative gearing
Negative gearing refers to the situation where investors make an investment (mostly in property) that loses money in the short term (e.g. loan and related costs are greater than rental income), in the expectation of making capital gains in the future.
The investor can deduct any losses associated with the investment from their salary and wage income.
For example:
James buys a unit as investment property, and his expenses for the property are greater than rental income, resulting in a $10,000 loss. James can use that $10,000 loss to reduce his $130,000 income to $120,000, providing a $3,700 tax subsidy to James.
Negative gearing is the investment process. But only a handful of countries, including Australia, allow investment losses to be applied to reduce salary and wage income.
However, the investment loss tax credit is not necessarily essential to successful negative gearing investment. The success of this investment strategy also depends on the payoff.
The payoff? The investment is sold at a profit (hopefully), generating a capital gain which offsets all the negative gearing losses. Understanding the nature of a capital gain, and a capital gain tax discount, are vital to understanding how negative gearing can be successful.
Capital gains tax discount
When an individual sells an asset for a profit, they make a capital gain equal to the amount of profit on the asset. They would then pay tax on that gain at their marginal tax rate.
Individuals, trusts are entitled to a 50% discount on the capital gain amount providing they have held the asset for more than one year.
For example:
Jane sells a property that she’s owned for 5 years, and makes a $150,000 capital gain over that period. Her annual salary is $190,000 in the year of sale. Applying the capital gains tax discount would see the capital gain reduced to $75,000, which takes her effective marginal rate on the capital gain from 47 cents in the dollar (top marginal rate) to 23.5 cents in the dollar, which is lower than the marginal rate of an average income earner.
Note that in the capital gains section above, the 50% discount is particular to Australia, not every country
Losing money to make money is only attractive to an investor if there is some kind of payoff that, at the end of the day, leaves the investor with a financial benefit. The two obvious benefits to negative gearing are:
• a possible tax credit for business losses during negative gearing, together with:
• a minimal capital gains tax when (or if) the investment is sold for a profit.
So, what’s the problem for affordable housing?
Schemes that support investment for its own sake in the housing market are sometimes claimed to somehow stimulate the production of more housing. A simple-minded invocation of the ‘Law of Supply and Demand’ suggests that the increased production of housing will trickle down to the affordable end of the scale.
Unfortunately, there is little or no evidence that negative gearing investment actually does stimulate the construction of more housing.
AND, increasing numbers of studies show that the housing market does not respond to a theory (not law) of Supply and Demand.
Meanwhile, it is certainly clear that investors are supported to purchase in the housing market through tax subsidies, whether business loss, capital gains tax subsides, or both.
This only serves to drive up the cost of housing, making it less affordable, not more affordable.
What does an examination of negative gearing offer everyone, including people in other countries?
One reason to fully explore the complete Australian Labor Party publication Positive plan to help housing affordability: it provides a deeper analysis of how tax subsidies negatively affect the housing market, while working to the advantage of those who are already wealthy, not struggling house-buyers.
A second, perhaps even more important reason to explore the article: it carefully explains how tax credits bleed the country’s treasury of enormous sums of money, year after year. In Australia, the loss to the treasury of negative gearing tax subsidies together with capital gains tax subsidies is estimated to be in the range of ten billion dollars annually.
For countries that depend upon tax credits to hopefully stimulate the building of affordable housing (e.g. America’s Low Income Housing Tax Credits, or LIHTC) the loss of government revenue is astronomical. The revenue is lost in exchange for somewhat questionable, and inevitably temporary, gains in the number of new affordable houses. At the same time, these tax credits both fuel and sustain the rising unaffordablity of the open market.
Finally, it should be noted that the Labor Party is not currently in power in Australia. That fact is no doubt a source of satisfaction to wealthy investors in the housing market. It won’t be shared so much by those first time homeowners facing the growing impossibility of ever owning a home, or even renting one at a reasonable cost.
