Warning: 3 reasons why negative gearing is in jeopardy

One of the Australian Labor Party’s (ALP) big election promises in the 2019 federal election was to abolish negative gearing. It would be logical to think that the ALP’s shock election loss in 2019 will serve as a warning for policy makers. That is, banning negative gearing is an unpopular policy. However, I would caution investors against assuming that negative gearing is here to stay.What is negative gearing?Negative gearing allows investors to offset property investment losses against other taxable income (such as employment income) to reduce their tax liabilities.For example, Colin is employed as a lawyer and earns $200,000 pre-tax. Colin’s employer correctly deducts $64,700 of tax. If Colin borrows $1 million to purchase an investment property, he expects to receive approximately $14,000 of rental income after all expenses (management fees, insurance, maintenance, etc.). The bank will charge him approximately $35,000 p.a. in interest. Therefore, the property will lose approximately $21,000 p.a. ($14k less $35k).Colin will be able to offset that loss against his employment income to reduce his total taxable income to $179,000 ($200k less $21k). This will reduce his annual tax liability to $54,900, which is a saving of $9,800 p.a. As such, the after-tax cost of the property is $11,200 p.a. ($21k less tax saving of $9.8k). This is called a negative gearing benefit.Why do people negatively gear?The only reason that you would negatively gear is that you anticipate that the property’s capital growth will eventually dwarf its income losses.Continuing with Colin’s example above, let’s consider the projected outcome after 20 years. Let’s assume the property continues to lose $11,200 per year which equates to $224,000 in total over 20 years. This assumes the rental income and interest rate do not change for 20 years, which of course is highly unlikely, but for the sake of simplicity, lets continue. If Colin’s investment property appreciated in value by 7% p.a. on average, it will be worth over $3.8 million in 20 years. After capital gains tax, Colin would have accumulated almost $2.2 million of equity in return for losing $224,000 of income. Most would agree that this is a good financial outcome for Colin.In short, investors use negative gearing on the expectation that the capital returns generated by an investment (often property), will substantially offset any after-tax income losses over time.Why is negative gearing at risk?There are three main reasons that I believe that tax benefits (savings) resulting from borrowing to invest in property will not be as substantial as they have been in the past. As such, I would counsel investors to not rely on negative gearing tax benefits when making investment decisions.Reason 1: Government will probably limit negative gearingThe expansion of federal government debt to over $1 trillion dollars means the government must generate more revenue to service and eventually repay this debt. One way to do that is to grow the economy (GDP) which will generate more tax revenue, even if tax rates don’t change. Another way is to raise taxes or limit deductions.Just over 11% of Australians invest in property (2.2 million people out of 19.8 million adults). However, only about 3.3% of Australians own 2 or more investment properties. Therefore, if the government limited negative gearing to say one property, fewer election votes would be at risk.I think the more likely outcome would be to introduce a dollar value limit. For example, maybe negative gearing deductions could be limited to $20,000 per year. Any negative gearing losses that exceed $20,000 could be carried forward tMy new book is available for pre-order now: Pre-ordering the book will help me get it into bookstores. So please do me a favour - please consider pre-ordering now - links and pre-order bonus are available here: https://prosolution.com.au/book-preorder-bonus Do you have a question for the podcast? Email us at [email protected]. If you're interested in working with our team and me, discover how we can work together here: https://prosolution.com.au/family-office-servicesIf this episode resonated with you, please leave a rating on your favourite podcast platform. Subscribe to my weekly blog: https://prosolution.com.au/stay-connected IMPORTANT: This podcast provides general information about finance, taxes, and credit. This means that the content does not consider your specific objectives, financial situation, or needs. It is crucial for you to assess whether the information is suitable for your circumstances before taking any actions based on it. If you find yourself uncertain about the relevance or your specific needs, it is advisable to seek advice from a licensed and trustworthy professional.