If you aren’t from Australia you are probably asking yourself – What is negative gearing and why is Glen talking about it? Well on the weekend I was at a 70th birthday party and I was talking to a couple of my wife’s relatives. The conversation started off around shares and some great penny stocks that I had been invested in recently, but the conversation soon turned to property and then negative gearing.
So what is Negative Gearing?
Wikipedia does a better job of summing negative gearing up than I ever could (read about it here), nevertheless, I will give it a whirl. Negative gearing is the term used to describe an investment in which someone has borrowed money to buy an asset (normally property) which is costing them more money in interest repayments than they are getting back from the asset. So in the case of property, the interest repayments are from the mortgage, and the money from the asset is the rental income. If the interest is greater than the rental return then the property is negatively geared.
Why Would Anyone Want to Do This?
In most countries, the idea of buying an asset that is going to lose you money seems like a really stupid idea – and it is… However, in Australia some genius (most likely sponsored by property developers) decided that the government should sponsor investors who were losing money on their investments, by allowing them to claim all expenses on the asset as a tax deduction (this includes deducting the interest on the mortgage loan).
Today this is one of the biggest legal tax rorts in Australia, and because of the amount of people involved, no government has enough balls to take it away as they know it would mean instant voter backlash and a very short term in office.
How does Negative Gearing Work?
The best way to show how negative gearing works is to give you an example. DISCLAIMER TIME – Now remember that I am not a tax accountant and that this example is general in nature. This information should not be relied upon as investment advice and I take no responsibility for its correctness or what you do with this information. Consult a tax agent if you have concerns regarding negative gearing.
Negative Gearing Property
Say you have a 30 year, $400,000 mortgage on an investment property @ 5.5% interest per annum (Note: negative gearing is only allowed on investments and you cannot negatively gear your principal residence).
That means that your repayments are going to be about $2270 per month.
You get someone to rent your property for $400 per week or $1733 per month.
That leaves a deficit of $537 per month or $6444 per year.
That $6,444 is now able to be used as a tax deduction. This deduction isn’t used just against your rental income, but also against your normal jobs income as well.
Negative Gearing Shares
Negatively gearing shares is very similar to property with the only real difference being the asset type. With shares you need to get a loan (a lot of people I know do this with interest only loans) and buy into a stock. The company that you invest in will normally pay a dividend, and if the dividend is less than the interest on the loan, then you qualify for negative gearing tax deductions.
Obviously the main goal with both of these types of negative investments is to make a capital gain and to minimize your taxable income.
Problems with Negative Gearing
My problem with all of this is three fold.
- People can end up paying little to no tax at all if they are willing to leverage themselves to the hilt with debt. This essentially means that the government is sponsoring people to become debt laden and to speculate on asset prices.
- These speculators are getting massive discounts on their tax, which means the burden of supporting the country through taxation revenue is greater on those who are unable to afford to speculate on assets. This essentially means the rich will get richer, and the poor will get poorer. On top of that, houses and stock market investing produces nothing of value for the economy. The government is sponsoring unproductive assets which provide nothing to export or make money back for the nation. I could understand sponsoring manufacturing, mining, agriculture, tourism and so on, but housing and stock price speculation – give me a break! What a load of baloney…
- Negative gearing promotes higher asset prices, which makes it that much more difficult for first home buyers to enter the market. I don’t see why the government should be able to decide that the previous generation should be able to laud it over the new generation who are just starting out in their careers and trying to buy into this ridiculously overpriced market.
Why Don’t I do it?
Interestingly, I probably will soon. Our primary residence is pretty much now paid off, and so long as the government isn’t about to change then I may as well look out for number one. There is no point paying more tax than I have to, especially when this is obviously what the government wants us to spend our money on. I mean I could start a small business and employ some staff, or I could speculate on stocks and properties instead. You be the judge as to which one provides more benefit for the economy in the long run…
What do you think about all this? Does it sound good / bad? And would you enter the ponzi scheme to reduce your taxable income?