Negative Gearing: Please Explain?

23/02/2016 8:23 PM AEDT | Updated 15/07/2016 12:51 PM AEST
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Apartment blocks stand in the suburb of Breakfast Point in Sydney, Australia, on Wednesday, Feb. 17, 2016. Australia's opposition Labor Party is proposing scaling back tax breaks for landlords that have helped fuel a 50 percent increase in property prices in capital cities since 2008. Photographer: Brendon Thorne/Bloomberg via Getty Images

Negative gearing -- Bill Shorten wants to change it, Malcolm Turnbull’s been defending it and everybody seems to be talking about it, but what the hell is it?

It is a part of life for Australian investors and as of late has become a hot topic in the property world, according to Associate Professor Jamie Alcock from the University of Sydney Business School.

“Negative gearing describes the tax treatment of losses relating usually to residential property investments,” Alcock told The Huffington Post Australia.

“[The] key component is that you can offset the loss against gains of other assets or earnings.”

So why the term 'negative gearing'?

To 'gear' an asset, such as a rental property, is to borrow money to buy it.

This asset is 'negatively' geared if it loses money, for instance the rent fails to cover the expenses incurred by the owner including interest payments on the loan, land taxes, maintenance and rates.

For example, if you have an investment property that earns you $40,000 a year but you have expenses amounting to $50,000, you have incurred a loss of $10,000.

Negative gearing then allows for an investor to deduct net rental losses against their wage income.

“If you earn $100,000 a year from wages and have a $10,000 property loss then you only pay tax on the net $90,000,” Alcock said.

Property investors are then also entitled to a capital gains tax discount of 50 percent once the property is sold.

A capital gain on an asset is the difference between what it cost you and what you receive when you dispose of it.

Generally, Alcock remains in favour of negative gearing, stressing that to change negative gearing laws could, in the long term, make it harder for first home buyers to stake a claim on the property ladder.

“A short-term response of changing negative gearing laws is, investors will start exiting the market,” he said.

“There would be a slight reduction in house prices in the short term but in the long term there would be less rentals available and rents will rise, making it harder for first home buyers to get on the ladder.

Bill Shorten has recently proposed that under a Labor Government, negative gearing would only be available on newly-constructed homes from July 2017 onwards.

However, there are no planned changes for existing negatively geared properties.

Another key tax policy measure announced by Labor was a reduction in the capital gains discount from 50 to 25 percent.

The Federal Government has remained tight lipped on its plans for negative gearing but Prime Minister Malcolm Turnbull has criticised Labor’s plans saying home owners across the country would see the value of the family home “smashed” by the “very blunt, very crude” idea.

“The Labor Party’s negative gearing policy and its wind back on the capital gains discount, or its increase in tax on capital gains, is a very dangerous one,” he said last Friday.

“It has been very, very poorly thought out. The consequence of it will be a decline in property prices.”

Turnbull and Treasurer Scott Morrison are currently under increasing pressure to reveal their plans for tax reform, which are expected to be seen in the handing down of the federal budget.

The budget is due to be handed down on the second Tuesday in May.

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