Should we invest in real estate in the future?

The current labour government has mentioned during their election campaign promises in the lead up to the next election that they would like to abolish negative gearing on rental properties. To understand this further, let’s look at the impact of negative gearing.

As per the current legislation, the following expenses can be claimed on a rental property:

  • Advertising for tenants
  • Body corporate fees and charges
  • Council rates
  • Water charges
  • Land tax
  • Cleaning
  • Gardening and lawn mowing
  • Pest control
  • Insurance (building, contents, public liability
  • Interest expenses
  • Property agent’s fees and commissions
  • Repairs and maintenance
  • 20% of Borrowing costs such the searches completed by the bank when the loan was established.
  • Depreciation on equipment and fixtures on the property
  • Capital works as advised by a quantity surveyor to advise

If the above expenses total more than the income received on that property for the year, this loss can be offset against other income to reduce the taxable income of that entity and therefore as a result of reducing the taxable income the tax liability can also be reduced.

However, if the negative gearing was to no longer be an option for properties that were not considered to be new, this would mean that the loss would not be able to be deducted from other income and property owners would be required to carry forward the losses associated with the rental properties until they sell the property.

For example, if Sam was to receive the following in the 2018 financial year, what would the impact of this be under the current system versus the potential new system:

  • Gross Salary of $70,000 and $15,756 of taxes deducted from the salary
  • Rental property loss of $6,500
  Current System New System
Taxable Income $63,500 $70,000
Tax on taxable income $12,184.50 $14,297.00
Medicare Levy (2%) $1,270.00 $1,400.00
Less: PAYG Withholding deducted from salary ($15,756.00) ($15,756.00)
Tax (Refundable)/Payable ($2,301.50) ($59.00)

This has resulted in a difference of $2,242.50.  As you can see there be a significant difference in the tax refund being paid to tax payers which can be used to repay the home loans and cover the costs of holding the rental properties, because we all know those costs continue to increase each year.

If the negative gearing provisions are only limited to the newer built properties, what will this do to the real estate market?  It will make it extremely difficult for properties to be sold especially if they are to be rented out and harder for the new home buyers to come into the market as they will be either competing with the investors for the newer properties or acquiring properties that will be harder to sell in the future.

Another item to consider is if the rental losses are not able to be used to offset the income in that year and are carried forward until the property is sold what if the following was to occur:

  • Gain from the sale of a property - $20,000
  • 4 years of Rental Property Loss carried forward - $26,000

Now suddenly, the property has made a loss on the sale and $6,000 is carried forward to a possible future gain.  So once again this results in $6,000 of costs and expenses that you are not able to benefit from until a gain is achieved.

Seems like this could be a difficult road ahead for all property owners.   It will be interesting to see how this all works out.