With the upcoming election I thought it would be best to talk about the elephant in the room and give you my thoughts on Bill Shorten’s proposed changes to negative gearing and the capital gains tax which will not only have an affect on my industry “real estate” but I believe a further flow on effect to the greater economy, this might be a very boring blog to read but it also might give you some valuable insight on where things could be heading. Hopefully you’ll enjoy it!
An Interesting Chart!
Negative gearing came in to play in 1985 and when you have a look at the above chart it had an enormous affect on house prices but in my opinion it wasn’t just negative gearing it was also the capital gains discount which was introduced in the late 90’s around the time when GST was introduced that really spike it when the two started working hand in hand together.
What is negative gearing?
Under Australian tax law, negative gearing is available to anyone who owns an investment property. If the money you make from rent doesn’t cover your interest payments and other costs, you’re allowed to deduct the difference—the loss you’ve made—from your annual income tax. Negative gearing can be beneficial to property owners, whose losses can push them into lower tax brackets.
“People think by negative gearing an investment property that they’re helping renters”— What they’re actually doing is entering auctions, bidding up the price of properties to ensure that people who would have once bought a house can’t, and then are renting it to them.”
What is the capital gains discount?
Under Australian tax law if you have held an investment for 12 months or more and sell that investment you’re entitled to a 50% discount on any gains made from that investment. The remaining 50% goes on to your taxable income for that year when you sold.
“You could point the finger at changes made to capital gains tax in 1999. Amidst the hubbub about the introduction of the GST, capital gains tax could be the culprit behind the last 15 or so years of skyrocketing house prices. Certainly the two may have worked hand in hand together.”
Why does negative gearing and the capital gains discount work hand in hand together?
With the capital gains discount introduced in the late 90’s, negative gearing was suddenly attractive. You could lose money in order to lower your taxes, but you wouldn’t ever really be taxed much when you sold at a profit. You’d get one part of this bargain by being able to write off deductions on your income tax, and when you finally sold the property you’d get the other part by not being taxed as high utilising the 50% discount on any gains.’
Australian capital city house prices have moved almost vertically upwards since the capital gains tax change was made. Today nearly two million of Australia’s taxpayers own one or more investment properties utilising the benefits of negative gearing and the capital gains discount when they sell.
The loss of tax revenue to the government is estimated to be between $5 and $9 billion, and many average Australians have been squeezed out of the property market due to lack of supply.
Why will Shortens policies changes hurt the property market?
Bill Shorten and the Labor party are trying to help the average Australian by making housing more affordable, by removing negative gearing from established properties he will essentially remove investors from that segment of the market. Investors will not buy an established property because they can’t negative gear the loss and claim tax deductions whilst holding the investment waiting for future gains and then not to mention when the do sell and realise any gains they will not get as big of a capital gains discount. A lot of investors will start to look elsewhere for opportunities putting further pressure on property prices.
But isn’t Bill still allowing negative gearing for new properties?
The answer is yes, because he still wants investment to create new construction to help the building industry and supply of dwellings to fill rental demand, however his system is a little flawed. Savvy investors in my opinion will appreciate that they can buy new, negative gear and still get some sort of discount on the capital gains when they sell. (Discount reduced to 30%) However when the investor wants to sell that new property, the next investor won’t be able to negative gear so they won’t be interested so investors buying new property in the beginning need to choose wisely with the new property because to get any gains they’d ideally be needing to sell to an owner occupier market.
Why is 50% down to 30% so significant for the capital gains tax discount under a Shorten government?
Let’s say you buy a property for $500,000 all in and in 18 months time you’re able to sell the property for $600,000 net. In the past out of the $100,000 gain you’ve made the first $50,000 has been tax free and the other $50,000 then goes on to your taxable income. Under the new changes that becomes $30,000 tax free and $70,000 going on to your taxable income, now believe me that 1. You’ve just lost $20,000 in tax free income and 2. You’ll be paying more tax on the $70,000 taxable amount not to mention 3. That the extra $20,000 (20%) in this example could also put you up into the next tax bracket.
What could be the consequences of Bill getting in and implementing these changes?
These changes are being implemented to making housing “more affordable” by taking the investors out of the established property market, so obviously this means there is a good chance that property prices could go down further.
By taking investors out of the market it limits competition so not only could prices go down further, with less incentive to invest property price growth could be much slower moving forward and not the boom times we have seen in the last two decades.
With a lack of investment in the established property market, rents could go up sharply due to a lack of supply of rental properties.
People who purchased before the current downturn caused by the royal commission and banks tighter lending standards could be subject to even further losses and even negative equity with further price falls.
Instead of people owning multiple properties, people may now choose to just own one home to live in and invest in other assets like businesses and stocks. This however could push up the prices on desirable principal place of residence properties, especially close to the city.
The flow on effect to the greater economy?
With the lack of equity due to lower prices and growth in the property market this could lead people to even tighter spending habits which could have a further effect on the greater economy potentially leading us into a recession which will affect everyone.
Australia has 3 major pillars that lead the market and work hand in hand with each other and they are: Mining which creates raw materials, raw materials are then used to create materials used in Building and Construction and our Financial Sector which helps fund Mining and Building and Construction.
With Mining being in a slowdown for several years we have become heavily reliant on Building and Construction and of course Finance. If Building and Construction slows then Finance goes with it and the 3 major pillars are all in trouble.
We have already witnessed with lower turnover in the property market and less stamp duty being collected that land tax rates have now gone through the roof, to help pay for all the governments expenditure.
If Australia goes into a recession, everyone will be affected one way or another. I’m not sure Bill should be making these changes in the current climate at a time where interest rates are at record lows and government debt is through the roof not to mention many economies around the world are also slow at the moment. It feels like that we don’t have enough ammunition to fight any big storms let alone potentially create one of our own.
Are there any positives or benefits of Bill getting in and implementing these changes?
There are always two sides to every story, Bill will argue that by making houses more affordable home ownership will be possible for your kids.
You could also consider that if property prices came down enough and rents went up enough we might be able to positively gear properties for once and use it as an income stream strategy for investment, instead of a tax loss strategy hoping for future gains.
In the short term I’d suggest there would be more pain in the adjustment phase with Bill’s changes and those who have bought in recently before the downturn at market highs will be the worst affected and may have no choice but to take a significant financial loss to re-adjust to the new rules.
It’s important to remember that any investment always carries risk and nothing is a sure thing. Video shops are no longer around due to Pay TV and now Pay TV is in jeopardy Streaming Apps. Taxi licence owners were printing money at one point before Uber came in and took over which also goes to show that governments do have power to break good things too.
Warren Buffett once said after sub prime “That a home is meant for family enjoyment and not really as a tool to continually use equity as an ATM.”
Real estate in my opinion is really a wealth preservation tool as overtime it’s a hedge against inflation and not only do you see capital growth overtime but you also get a return from rent if it is an investment. Gold and Fine Art are also wealth preservation tools like real estate but only offer capital growth so potentially real estate is the best of all 3.
The most money is made through successful Businesses followed by stocks should you be lucky enough to be in the right industry at the right time and or are lucky enough to invest in the right ones at the right time. That’s where the real money is made in my opinion although it’s the toughest game to make money hence the big returns should you succeed.
All and all with investing whether its business, stocks, real estate or commodities “like gold” it is generally best played for the long term and maybe Bill’s changes might be painful in the short to medium term but perhaps in the long term they may work out? Who knows but If Labor win the election I guess we’ll see.
I’m very confident though that property is a necessity like food as shelter is needed so I don’t expect property to be worthless and it has certainly always appreciated overtime with or without negative gearing so I’m still a believer in it.
Thanks for reading, the above are my thoughts and opinions and are not to be considered as investment advice, investment carries risk and you should consult your accountant and or financial adviser before asking any investment decisions!
I’m not really political and this is certainly not a dig at Labor or Bill Shorten but when you vote in the upcoming election all I can suggest is that you “choose wisely”.
Feel free to contact me if you have any real estate needs!