Negative gearing
Negative gearing is a tax strategy primarily used in investment, particularly in real estate, where investors borrow money to purchase properties. In this scenario, the income generated from the property falls short of covering interest payments and other related expenses, resulting in a financial loss. This loss can be deducted from the investor's taxable income, reducing their overall tax burden. While negative gearing can present advantages, such as increased rental property supply, it has sparked significant debate about its impact on housing affordability and market dynamics. Critics argue that the practice predominantly benefits higher-income individuals, often leading to inflated housing prices and limited access for prospective buyers. Countries like Australia, Canada, New Zealand, and Japan permit negative gearing, with Australia having a particularly notable history of utilizing this strategy. Reform discussions have emerged around limiting the practice or adjusting tax benefits, reflecting ongoing tensions between investment incentives and housing market accessibility. Overall, while negative gearing serves as an appealing tax minimization tool for many investors, its broader social implications remain contentious.
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Negative gearing
In business and finance, negative gearing is a tax minimization strategy. In negative gearing, investors borrow money to make an investment, but the income received from the investment is less than interest payments and other expenses. The investor's loss can be deducted from income taxes against other income. Negative gearing reduces taxable income and the amount of taxes an investor pays.
Negative gearing is often used in property investments. Investors hope to offset their loss in the future by selling the property for a capital gain. Countries that allow investors to claim the tax deduction include Australia, New Zealand, and Japan. Canada, France, Germany, Sweden, and the United States allow this tax deduction but only under special conditions.
Negative gearing is advantageous for investors, but the practice has come under scrutiny. According to tax data, negative gearing mostly benefits the wealthy. Critics argue the practice results in driving up rental prices and decreasing housing affordability.
Background
Gearing refers to borrowing money to buy an investment asset, usually investment properties. There are three types of gearing, with each dependent upon the income earned from the investment.
Positive gearing is when the rental income, or the amount of rent received from tenants, is greater than the interest payments on the loan and the expenses to maintain the property. This means the investor is making a profit, and the investment provides an ongoing source of income. However, the investor will have to pay tax on the additional net income.
Neutral gearing occurs when the rental income is equal to the interest payments on the loan. This means the investor is breaking even.
In negative gearing, the rental income is less than the interest payments and maintenance expenditures. This means the investor is experiencing a loss. However, investors can sustain the loss by having an additional form of income to cover the shortfall. They can deduct the loss generated by the rental property from their income taxes, thereby lowering the amount of income that can be taxed. As a result, investors pay less in taxes.
Investors who engage in negative gearing believe they will eventually benefit from the property's capital growth, the increasing value and worth of a property over time. Negative gearing only generates a profit when the investor sells the property. Upon the sale of the property, the investor hopes to receive a capital gain, the increase in the rental property's value and worth as compared to its purchase price. Negative gearing pays off for investors when the money made from the capital gain is greater than the loss incurred from the shortfall in rent.
Negative gearing is optimal when the interest rates on the loan are either fixed from the start or stay low if based on a floating index. A profit can be attained when property values are on the rise.
In Australia, the practice of negative gearing is widespread. In 1999, the government changed the capital gains tax: 50 percent of the profit from the sale of investment properties is untaxed. This made the buying of rental properties more attractive.
Over one million Australians use negative gearing. The Australian government is estimated to lose over $6 billion a year in income tax revenue because of negative gearing.
Overview
Negative gearing has obvious benefits for investors, such as lowering taxable income and reducing taxes. It creates investment opportunities for people of all income brackets. The practice also encourages landlords to rent out more properties, increasing the housing supply.
But the tax strategy has spurred controversy and calls for reform in Australia. The issue has generated questions as to which taxpayers benefit the most and how it affects housing prices and affordability.
Negative gearing is used by people across all professions. In Australia, however, the people who are most likely to engage in the practice and receive the greatest benefit are those in higher-income occupations, according to an analysis of tax data by the Grattan Institute, an independent Australian think tank.
Research indicates that individuals who perform the most negative gearing are in higher income brackets, including surgeons, nurses, anaesthetists, accountants, school principals, information technology managers, and mining engineers. The Australian government eliminated negative gearing from 1985 to 1987, during which time rent prices jumped. When the practice was reinstated, the political reasoning was that negative gearing keeps rental prices down.
Critics of negative gearing argue the tax deduction encourages speculative buying in the country's real estate market, which, in turn, drives up housing prices and decreases affordability. From September 2003 to December 2014, the price of rent increased more than the price of new homes bought by owner-occupiers. This trend continued in the following decade, and between 2020 and 2024, rent prices in some areas rose more than 35 percent.
There are a few ways the Australian government can limit negative gearing. The government could cap the number of properties that investors can use for the practice. This would minimize the amount of income tax revenue that the government would lose through deductions. Negative gearing could also be restricted to new properties. Another option is to lower the capital gains tax and thus reduce the amount of profit that would go untaxed, which would provide less of an incentive for investors.
In 2016, Australia's Labor Party proposed restricting negative gearing to newly constructed homes and grandfathering in existing investments. The party also proposed cutting the capital gains tax from 50 percent to 25 percent. However, Australian Prime Minister Malcolm Turnbull dismissed making any changes to negative gearing, arguing the Labor Party plan would lessen the value of all homes in the country. Similar proposals were discussed in subsequent years, but changes were not implemented.
Negative gearing is a controversial tax strategy that aids investors at the expense of the government. In Australia, the practice will likely stay in place as more than one million taxpayers seek to continue reaping the benefits. Negative gearing is vulnerable to reform, as studies show the strategy aids the wealthy and threatens the affordability of housing.
Bibliography
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