Peter O’Brien on negative gearing

One of the most frustrating things about being an observer of the political scene is how easily politicians are let off the hook when they make misleading or specious claims.   The most outrageous illogicalities are meekly accepted by a media class that seems to have abandoned any pretence at intellectual rigour.

The usually astute Chris Mitchell has a piece in the Australian in which he opines:

In my view, a cap on the number of negatively geared properties is desirable to prevent high-earning surgeons and lawyers avoiding all tax by owning dozens of negatively geared properties.

As someone who, along with my wife, has based my retirement on property investment, I am always irritated when politicians and commentators routinely conflate property investment with ‘negative gearing’ – as if tax avoidance, rather than wealth accumulation, were the primary motivation.

And I am particularly intrigued by these canny surgeons and lawyers who are able to ‘avoid all tax’ through negative gearing.   I know a few surgeons and lawyers but none of them are in this category, so I have to imagine how the others do it.

Let’s say I’m a brilliant surgeon earning $1,000,000pa.   I pay a top marginal rate of 45c in the dollar.  So before any deductions I may have, I pay $423,097 income tax.

For the purposes of this example, let’s ignore all other deductions.  That leaves me with $576,903.

Let’s say I decide to live on half of this and, each year, to put a $300,000 deposit on a rental property worth $800,000.  I need to borrow $500,000 and secure an interest only loan over 30 years at 6%. (In reality, I wouldn’t maintain an interest only loan over such a long period but would pay down principal wherever I could but for simplicity’s sake go with me here).

Let’s say I get $600 per week rent – $31,200.

I am paying $30,000 p.a. interest on my loan.  That is tax deductible.

Let’s say I pay annual rates of $2,000 and insurance of $1,000.

And I engage a managing agent who charges, say, 10% or $3,120 pa.

My outgoings are $36,120.

So I’ve made a loss of $4,920.

So now my taxable income is $995,080 and tax payable is $420,883.  So I’ve ripped off the government to the tune of a measly $2,214.

Let’s say I do this every year for the next 20 years.  I now have 20 properties all structured the same way.   My annual loss is now $98,400 and my annual tax bill is $378,817, a saving of $44,280.  But I’m living on $53,720pa less than I otherwise would have.

In short, I’m a hell of a long way short of ‘avoiding all tax’.  Cultivating losses to avoid paying tax as an end in itself does not strike me as a good way to accumulate wealth.  Ultimately, short of breaking the law, tax must ultimately be paid.  The best you can do is delay paying it.

Does this seem to you a very unlikely scenario?  This is a very simplistic example.  I have deliberately and artificially structured it as a worst case scenario – one that produces the best outcome from a tax avoidance perspective.  Any tweaks to the scenario I have outlined above, to make it more realistic, eg incorporating regular rent rises for the older properties, regular increases in income, paying down principal etc etc, would all have the effect of reducing the tax avoidance potential.

A throwaway opinion in an op-ed in The Australian is not, of course, a world shattering matter and I would normally not have bothered to respond but Mitchell’s comments play into the Labor myth that property investment is just a tax dodge for the wealthy.    In fact, this is of a theme with the general subversion of the English language that passes for political debate.  The corruption of words such as ‘racist’, ‘sexist’ and ‘homophobic’ are the obvious and worst examples but there are many others.

For example we hear a lot now from Shorten and co, and echoed by many journalists such as Peter Van Onselen,  about ‘closing tax loopholes’, by which they mean the discount on CGT, negative gearing, tax deductions for accountancy fees etc.  A ‘loophole’ is a device unintentionally created by a deficient drafting of legislation that allows someone to legally circumvent the intention of that legislation.  All the tax provisions, relating to discount of capital gains tax, negative gearing etc that Labor do not like, are not loopholes – they have been specifically legislated to achieve a particular outcome.  If Labor wants to change that outcome as part of their tax grab that’s their business but they should refrain from smearing those who legitimately use these tax provisions as shysters taking advantage of a ‘loophole’.

As long as we have journalists parroting the Shorten li(n)es, what chance has the normal voter got of getting close to the truth, especially in this social media dominated world?

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30 Responses to Peter O’Brien on negative gearing

  1. yarpos

    “One of the most frustrating things about being an observer of the political scene is how easily politicians are let off the hook when they make misleading or specious claims. ”

    From Bill Shorten

    – Labor will invest in renewables to lower power costs (the Fair Go video advert)
    – EVs take 8 or 10 minutes to charge (ABC interview, cant even handle a softball question)

    I will ask my local Labor candidate how, but I know the they (or more likely and underling) will just email a boilerplate response from Labor HQ

  2. Elizabeth (Lizzie) Beare

    We have invested in property, to the tune of three or four investment properties, and upgrading every six years our own home via sale and new purchase ready for further renovation which also increases this asset. We’ve done this over the years to be comfortable in retirement as well as having various sorts of superannuation income. One thing that always gets me when the left slag off at multiple property ownership is they ignore the risks you take with this. The bad tenants, the rise in interest rates, the property maintenance that blows out of all proportion, and various rip offs you encounter as well as sometimes flat capital gains, depending on area. If you are going to be in this sort of small business then as with any other you do have to know the market, study it, and sometimes seek professional advice about aspects of it, plus accounting fees and legals for various issues. Yes, you can tax deduct some of your costs but the real costs can also be high; as well as the opportunity cost of not doing something perhaps more profitable with your money.

    The left also ignore the worry of it all and the amount of time you have to spend, even with the best of property managers, in keeping track of everything, the financials and the decisions about buying, selling, renovating and leasing. Plus if you have units, getting busy on the Owner’s Corporation can sometimes be a necessary protective measure (never buy units, they are over-regulated to the hilt now and house and land always gives a better return). When a husband has a busy career, as mine had, it is often the wife who has all of this extra work. Property investment is a business and in many families it is a small business and functions in the economy much like any other small business; it delivers a very useful service, providing market-based rentals. I’m glad we’ve mostly sold up now except for our home, and have retired with spare money to invest and spend, plus a decent income. Then along comes Billie Boy looking very hungry …… oops.

  3. Tel

    Thinking on the margin … what is the biggest threat to ALP and their envy politics?

    Long term welfare dependents will vote for more welfare, but they aren’t on the margin. Wealthy tax donkeys will attempt to vote for less tax (good luck) but they aren’t on the margin either.

    The marginal people are the upper working class and lower middle class with aspirations to perhaps start a small business, put together some savings, perhaps not end up wealth but reach the point where they have something to lose. Many of these people escape the rat wheel by using negative gearing as a vehicle. It’s not useful for the very poor, not is it worthwhile for the very wealthy. Blocking negative gearing is simply a way of keeping the aspirationals on the plantation. Tragic … but ruthlessly efficient.

  4. Tel

    In short, I’m a hell of a long way short of ‘avoiding all tax’. Cultivating losses to avoid paying tax as an end in itself does not strike me as a good way to accumulate wealth. Ultimately, short of breaking the law, tax must ultimately be paid. The best you can do is delay paying it.

    Delaying the tax implies reducing it, because the idea is to retire first and then the income from the property becomes positively geared as those loans get paid down. Generally that will put you into a lower tax bracket. Many professionals can retire in a tapering off fashion if they choose to and only earn the right amount each year to make it worthwhile.

    However, at $1M per year raw income I would not doubt there’s a lot of options on the table for retirement schemes. I’m not a tax expert but if you hired one you could probably do better than simple property investment.

  5. Habib

    They agree with the larcenous dwarf. Journalism is dead.

  6. Elderly White Man From Skipton

    POB, I think you should be worried about this. But for other reasons.
    Australia is the only tax regime in the region that allows negative gearing. It is also the only one with so favorable a capital gains tax regime.
    As it happens, property is the absolute favourite investment of many in the region, especially in places like HK. As the laws on foreign investment in residential property were relaxed, and the markets for debt and so on were so favorable, Australia has been a honeypot. It’s hard to know what the effect has been but I draw your attention to the RBA data on loan syndications since 1992 (the last big property crash).
    HK property markets are like casino betting. My guess is that Australia’s curious composition of rules has created a big liability for people like you.

  7. JB of Sydney/Shanghai

    Perhaps younger Cats have never seen this clip.
    Kerry Packer versus politicians.
    It summarises pretty much all you need to know about the useless dills we have in Australian Government.

  8. Zulu Kilo Two Alpha

    Perhaps younger Cats have never seen this clip.
    Kerry Packer versus politicians.

    I have the immortal words about “minimizing my tax” on my office wall, as does my accountant.

  9. DaveR

    Does this seem to you a very unlikely scenario? This is a very simplistic example. I have deliberately and artificially structured it as a worst case scenario – one that produces the best outcome from a tax avoidance perspective.

    One comment: legally allowed tax minimisation perspective.

  10. John Stankevicius

    Paul Keating sopped negative gearing in the late 1980ds and new properties dropped by 33.33%. Negative gearing is required for property due to the high buy in price. As mentioned above the risks are huge. The best way to buy a property is through a smsf. The banks don’t like it as your loan term reduces by 1/3. The biggest issue is the govt component in property.

  11. David Brewer

    More plausible scenario for a successful property investment:

    Borrow $600K on the $800K place, interest bill now $36,000 instead of $30,000. Loss for tax purposes goes up from $4,920 to $10,920.

    Deduct $2,000 for depreciation. Reportable loss now $12,920. Rates and insurance probably more like $5,000 than $3,000, and you are going to have some repairs, say $1,000 a year. Tax loss now $15,920, and tax saving $7164. Actual cash loss after excluding depreciation and deducting tax saving is $6,756.

    After 10 years, sell the place for $2 million after costs, capital gains tax bill $270,000, possibly slightly reduceable by stuffing part of the gain into super. Net profit $930,000, minus the $67,560 in accumulated after-tax rental losses, so final net proceeds after ten years of $862,440 on a $300,000 investment, a 187% profit.

    So you can see what B.S. is coming after. He’s a bit late unfortunately. With the downturn in the Sydney and Melbourne property markets, the above scenario is already looking dated, and we may not see its like again for many a long year. The whole trick of negative gearing is to get current deductions from tax at top marginal rate but to pay only half that rate or less on the hopefully large capital gain that is building up in the asset. A lousy capital gain wrecks the strategy, and if the gain drops below zero after costs, which would now be the case on most Sydney and Melbourne property bought in the last 4 or 5 years, then you end up with both current losses and a capital loss, the latter being not deductible from ordinary income.

    In principle, however, I don’t see the justification for allowing negative gearing. Sure, costs incurred in earning assessable income should be deductible – but the purpose of negative gearing is not to generate assessable income but to reduce it.

  12. duncanm

    I don’t see how any new tax laws restricting negative gearing deductions can ever work.

    Say they implement something — I’ll set up a company whose sole purpose is to invest in property (let’s call it a property trust).. and I’ll invest in that.

    Now my investment losses are legally deductible.

  13. Neil

    I read somewhere that unless your investment property goes up in value by 5%/year you will be losing money and it would be better to leave your money in the bank

  14. Rob MW

    As long as we have journalists parroting the Shorten li(n)es, what chance has the normal voter got of getting close to the truth, especially in this social media dominated world?

    This much !

  15. Entropy

    Mrs Entropy just got a call from a very nice old dear who then proceeded to read from a script about how Scott Morrison had stripped all this money from PA hospital budget.
    Mrs Entropy was very polite and listened. I asked Mrs a Entropy once she got off the phone how could the prime minister of Australia micro manage a Queensland government owned and funded hospital.

    Mrs entropy informed me that of course he can’t, but she was going to argue with the nice old lady who rang up.

  16. Entropy

    Wasn’t going to argue.

  17. Jumpnmcar

    As long as we have journalists parroting the Shorten li(n)es, what chance has the normal voter got of getting close to the truth, especially in this social media dominated world?

    It’s not the new internet media that’s the problem, it’s the dying dinosaur main stream media in its last breaths that’s the problem.

  18. Chris M

    A lot of boomers supported Labor over the years (LibLab are exclusively Boomer run after all) so it’ll be fun to see how this plays out, together with the collapsing real estate market.

    In the above investment scenario state governments do very nicely from stamp duty on each sale also, so it’s very much in their interest to have constant activity and turn over. Flat / declining market is exactly what we need but it’s only helpful to younger folk trying to enter the maket so they don’t want that that.

  19. Harpo of Wolli Creek

    Yeah, and after 20 years the surgeon owns twenty properties worth in total say $30 million, all gained while sitting on his arse. While accumulating this massive fortune he has removed from the market 20 properties that could have been bought by young people struggling to get a foot on the property ladder.

  20. Yohan

    Negative Gearing creates housing market distortions, where higher income earners can outbid those on low incomes to a greater extent than normal. But you cannot just remove negative gearing while keeping income tax rates so high.

    A better solution is to give wage earners a low flat tax rate, such as 10-15%, that allows no deductions at all. The government gets a flat cut of all wage income, no deductions or exceptions. Yes you can deduct housing investment losses from your housing profits, but not your wage income. This would remove most distortions and tax dodges, while also streamlining revenue raising. The incentive towards asset speculation would lessen, while incentives to starting a business (actual production) will increase.

  21. RobK

     I’ll set up a company 
    Exactly.

  22. John Stankevicius

    Dave and Harpo
    Your positions are one of envy.
    Investment to improve one self should be encouraged and not derided.
    Paul Keating removed negative gearing in the late 80s and construction of dwellings collapsed by 1/3.
    Negative gearing for properties provides the vehicle available for accomodation to be made available to those who can’t afford to buy.
    It is not negative gearing which has caused the affordability issue but immigration. Immigration in Sydney and Melbourne at 75,000 people a year over 12 years – how are you going to build 20, 000 homes in each of those cities in one year.
    I see the results here in Adelaide where the cream brick flats are crammed with a family of 2 children spilling out into the driveway and road .
    Negative should remain in tact as should capital gains as it provides incentive.
    I remember havin a conversation with Terry McMaster who asked me how many people do you know that own a home, and then one rental property. From the 100s of people I know I could not count past my first hand.

  23. Cynic of Ayr

    I don’t know a lot about negative gearing, but I do know a little about retail sales.
    Negative gearing. If I own a proper, and do maintenance or repairs on it, the costs are tax deductible. However, if I sell the property at it’s now repaired and pristine condition for more than I paid for it, I pay tqx on the capital gain. Now, for simplicity, the capital gain I made is equal to the repairs. Sameo sameo, in my opinion.
    Retail. I buy something for ten bucks, intending to sell it for twenty. Profit of ten, tax on ten.
    However, as likely, no one wantsa the darn thing. So, I write it off to ten cents, claiming a loss of $9.90.
    My taxable income is reduced by $9.90.
    Now, some sucker – sorry, astute buyer – come along and asks me the price. Twenty bucks. Sold!
    Now, I have an item worth ten cents, I sold it for twenty bucks, a profit of $19.90.
    My taxable income went up by $19.90.
    The Tax Man always gets you. Same with Negative Gearing. The Tax Man will get his money, one way or the other.
    Chris Mitchell is merely writing something that he hopes will be read by someone, maybe being considered to be one smart feller as a bonus.
    Peter Van Onselen on the other hand, is merely an idiot, and a Professional Idiot to boot.
    Unless you really stretch the realms of decency and perhaps the law – think Richo – then there’s really no such thing as dodging tax.

  24. The BigBlueCat

    Harpo of Wolli Creek
    #2989769, posted on April 16, 2019 at 10:44 pm
    Yeah, and after 20 years the surgeon owns twenty properties worth in total say $30 million, all gained while sitting on his arse. While accumulating this massive fortune he has removed from the market 20 properties that could have been bought by young people struggling to get a foot on the property ladder.

    And taken the risk of holding the assets whose values could realise him no gain. And in the meantime provided good properties to the rental market (some of which will have been trashed by tenants and the good doctor having to spend more money bringing them back up to scratch).

    BTW – he’s investing in properties already outside the reach of new entrants into the market by virtue of his primary source of income – how is he removing “from the market 20 properties that could have been bought by young people struggling to get a foot on the property ladder”?

    The problem with leftists is that investors are doing the things they wish they themselves would do, but don’t because they are fearful of the risk, or don’t have the primary income that makes the investment worthwhile.

    It’s the politics of envy that we’re talking about here … the leftists seeing someone get ahead and then, thinking that person has too much, either demands they share their wealth (via government/taxation force) or be prevented from achieving the wealth in the first place.

    We have a progressive (regressive?) tax system now – the leftists want to make it more regressive by screaming “fair share” (despite the fact they are already paying in accordance with tax legislation – just scream “fair share” does not make current laws “unfair” – prove your point). They care not one bit about the flow-on effects to the rest of the economy. If it ain’t broke, don’t fix it!

  25. Harpo of Wolli Creek

    For the elucidation of The BigBlueCat-1) the possibility of some of the properties being trashed is embedded in the rent and is another tax deductible expense. 2) there is no rational reason why a wealthy negative gearer needs to buy only up market properties that are out of reach of the first home buyer. They can as easily buy two 400,000 properties and much the same effect is achieved. 3) there is a ratchet effect to consider. If the surgeon removes twenty properties from the market then the next prospective negative gearer has to chase a more limited number of properties, driving up the price of properties in the tier below the surgeons portfolio. 4) though the land and the house are inextricably linked there is no good reason why the value if the land in the house/ land package should be a tax deductible expense. One cannot after all claim a tax deduction for the interest payments on any other purely capital item, eg a piece of art.
    You call it the politics of envy. I call it the politics of greed. We seem to be moving rather rapidly towards a return to feudalism, and I think that negative gearing and virtually open slather for wealthy overseas buyers are accelerating that trend. Why anyone thinks that making the purchase of a place to live increasingly unaffordable just to placate a limited number of wealthy superannuants is a mystery to me and one of the great evils of our time.

  26. John Stankevicius

    Big Blue Cat
    You hit the nail on the head . Lefties are frightened and risk adverse – that’s why they work in the PS.
    I have acted for these people and on the main they are poor clientele.
    Harpo – I am 180 degrees opposed to what you say. Immigration and govt policy are what is contributing to the property shortfall.
    What is happening is Soviet apartment blocks are mushrooming in the established suburbs while families, those with high expenditure are buying 800 to 1200 square metre blocks on the outskirts. Now families have to travel further to work and more time in traffic.
    Your comment about feudalism I can relate to. Govt in thy feudal master, wage increases of 4.5 % each yr while private salaries go backwards, 14.5% super while private industry can only afford 9.5%,
    If your earn over $200k in private industry you pay an extra 15% on super, if you work for the govt you are deemed a high ranking employee exempt from this surcharge. If you are a govt employee you can contribute as much as you like into your constitutionally protected super fund and pay no tax on this while a private individual will have to pay tax at your marginal rate.
    Oh yes constitutionally protected funds pay no tax while your smsf pays 15% and has to deal with over the top compliance requiements.
    That is your feudalism Wally.

  27. The BigBlueCat

    Harpo of Wolli Creek
    #2990235, posted on April 17, 2019 at 3:00 pm

    I think John has covered it quite well. Perhaps rather than being worried about how others, in providing much-needed accommodation to the rental market through the legitimate (and desirable) structuring of their finance and tax profile, you could yourself look at preparing for your eventual retirement and use the same structures to maximise your wealth opportunities.

    I don’t understand why you concern yourself over someone else’s supposed greed (a plea to emotion if ever there was one) except that you envy what they have (if you can’t have it, they shouldn’t either?). I guess you could call it “moral outrage” that others are so wealthy, but they don’t necessarily get that way by immorally exploiting others. It’s not immoral to have wealth, is it? Don’t we all aspire to have wealth? Does that make us all immoral in that regard? I put it to you that to not aspire to have wealth is to be economically lazy. We should all aspire to be independent from the government in terms of our ability to pay our bills and secure our economic future. If we look to the government to provide for our future means of survival, they are sure to disappoint.

    Negative gearing was introduced to help solve a housing shortfall problem. The problem, it seems, still exists, and negative gearing plays a significant part in addressing the problem. So why change the rules because “greed” or “envy”? I would argue that the ALP is being “greedy” for tax income by making the change. Government greed is usually the worst kind of greed.

  28. David Brewer

    BBC, two of your arguments against Harpo don’t stand up in my view.

    rather than being worried about how others […are…] structuring of their finance and tax profile, you could yourself look at preparing for your eventual retirement

    Harpo’s point is that negative gearing is a rort. Telling him that instead of worrying about it, he should come on over and join the rorters is not an effective counter-argument.

    Negative gearing was introduced to help solve a housing shortfall problem. The problem, it seems, still exists, and negative gearing plays a significant part in addressing the problem.

    Any solution that has not fixed its problem in 30 years is not much of a solution. And if negative gearing is still leaving a supply shortfall now, with prices having been at astronomical levels for years, what evidence is there that it is doing any good at all?

  29. The BigBlueCat

    David, negative I’ve Bering isn’t a .org, it’s an incentive. Therein lies the difference. Bill Shorten wants to just the incentive to lower house prices in a market that is already seeing steep decline due to the banks and other factors.

    I don’t have skin in the negative gearing “game” but I see the logic in maintaining negative gearing certainly on new properties, but also on old properties. Keaton’s took negative gearing way and it was a disaster, and he had to restore it.

    Whenever the ALP adjusts taxes because of “rorts” and “rich” and “greed” they usually get it wrong and the economy suffers for it. Remember the recession we had to have? Interest rates over 20%? Massive structural deficits? Gee, I can’t wait for that to happen again under Labor … (/sarc)

  30. The BigBlueCat

    That should say “Negative gearing isn’t a rort, it’s an incentive.” … typing on an iPad here ….

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