THE Labor Party have announced that, if elected, they will abolish negative gearing for established houses from 1 July next year.
It's a dangerous policy that is bound to have serious unintended consequences. Obviously, one of these will be a fall in the value of established homes after July 2017.
Contrary to the spin, Australians who are using negative gearing to increase their wealth are not millionaires flouting the tax system - they are contributing to it long-term.
Think about a typical couple earning $80,000 a year each. They are about to turn 50, have just paid their house off, and are well aware there's unlikely to be much of a pension available to them when they retire.
The options available to them are cash, property and shares. Cash is particularly unappealing, with rates at historic lows and likely to fall further.
They are terrified of shares and are becoming increasingly wary of super, due to the barrage of calls to change the rules yet again.
The only option left for them is property. They are not interested in non-residential property, where vacancies of a year or more are common, so their choice of asset to build a portfolio for their retirement is residential real estate.
They decide to bite the bullet and borrow $450,000 at 5%, secured by a mortgage over their existing home, to buy an established property for $450,000.
Repayments of $3560 a month will have the property paid off in 15 years when they want to retire.
In Year One, the net income from the property will be $18,000, and the interest for the first year on their loan will be $22,500.
Hence they are negatively geared to the tune of $4500 and should qualify for a tax refund of around $1250 each when depreciation allowances are taken into account.
The total cost to the taxpayer is just $2500 - hardly the stuff that grand tax schemes are made of.
Now fast forward to Year Five, when their net rents are likely to have increased to $21,000, while their loan is down to $339,000. Their interest deduction for the year is just $16,950.
Lo and behold, they are now positively geared. In fact, the surplus rents may well push them into a higher tax bracket, unless our squabbling politicians have got their act together and agreed to personal tax cuts in that time.
But here's the rub, the way to make money in real estate is to buy a run-down property in a good area from a vendor or who is keen to sell and add value by improving it.
The Labor proposal would steer investors into new properties where the potential for gain is much less.
Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: firstname.lastname@example.org
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