Gearing is borrowing
to buy an asset
with a small personal contribution and
borrowing the rest from others
Property investors aim to earn income from the property in the form of rent in the short term and a capital gain, long term.
Property investment is negatively geared when the rental income doesn’t cover all the costs associated with owning the property.
The Australian Tax Office allows property investors to reduce their taxable income by the amount of the shortfall.
It is also important to note that property can be positively geared, where the income received exceeds the holding costs. Neutrally geared property exists where after all income and expenses are calculated, the property ‘breaks even’, that is the rent covers the expenses but no more.
Any property can be positively or neutrally geared depending on the LVR and the size of the investor’s contribution.
Typically though the idea of a positively geared property relates to the concept of the rent exceeding the holding costs with only a minimum deposit, this is more likely in rural areas where prices are low and rents are typically much higher relative to the purchase price.
Why negative gearing is here to stay
= “Why negative gearing is here to stay…”] Once again the idea of changing the tax benefits afforded to investors via negative gearing has been floated in the context of broader tax reform.
Australia is a market economy and, in a perfect world, freely operating markets are efficient and deliver maximum satisfaction for all. But it isn’t an ideal world. Sometimes market solutions are inadequate, inequitable, and lacking in social responsibility- you only have to look at the causes of the GFC to see a classic example!!
There is a role for government to redistribute income and resources in ways that enhance market solutions and compensate for market failure.
Tax benefits for negatively geared investment property are a perfect example of government policy designed to achieve a desirable market outcome. The government provides tax incentives for individuals to invest in property, especially new property, thereby increasing the stock of available housing and delivering significant employment opportunities as a byproduct. The stimulus to private sector property investment through tax concessions helps to redress the housing imbalance and reduces pressure in the rental market.
It also importantly promotes entrepreneurial spirit, the building block of the market system, and is an incentive for individuals to create wealth for their retirements, thereby reducing the burden on future generations. Shifting the goalposts to be eligible for the age pension to 67 after 2023 is in direct response to the looming crisis in the economy’s ability to support an aging population that no longer contributes to the public purse.
We all need to become proactive now so that we don’t end up reliant on the overstretched welfare system in the future. It is also essential to understand why tax benefits are maximized on a new property through depreciation.
Depreciation means that you are allowed to claim a proportion of your property’s value, the building and its fixtures and fittings, for wear and tear over time as another cost of ownership. This claim is most substantial in the early years of a property’s life and so building a new property is the best way to take advantage of the ATO’s concessions.
A healthy building industry is vital for economic growth and employment. The multiplier effect of construction means not only work for tradespeople and suppliers, but it has a ripple effect on the retail industry for white goods, carpets, blinds, turf, fencers, landscapers, moving companies, and the list goes on! No wonder the government considers ‘housing starts’ a leading economic indicator.
Policy changes involve trade-offs and disincentive effects, both intended and unintended. Removing tax advantages for property investment would reduce the supply of housing and put the onus back on the public sector to provide more public housing.
Housing construction is an important injection into the circular flow of income in the Australian economy – it is an essential driver of employment.
Construction contributes approximately 8% of GDP and employs more than 1 million people.
Indirectly, many more workers are employed to provide the complementary goods and services that housing (both residential and commercial) necessitates.
To stimulate housing starts and the economy through the multiplier effect of construction, the government provides generous INCENTIVES and CONCESSIONS for those investing in a brand new property.
A depreciating asset is one that has a limited effective life and can reasonably be expected to decline in value over time.
Property investors can claim depreciation as a non- cash deduction as a cost of owning the property and renting it to a tenant. Non- cash refers to the fact that the money doesn’t have to be paid out by the owner first, it is merely an allowance made by the Australian Tax Office for investors to reduce their taxable income.
There are two categories of depreciation allowances available to the property investor:
CAPITAL WORKS – (the constructed building) can be claimed as ‘losing value’ (even though market value increases) at a rate of 2.5% pa for 40 years. (2.5% x 40 years =100%) This concession applies to both new and resale property (under 40 years old)
FIXTURES & FITTINGS –
You can claim for new assets; not second-hand or previously used.
This allowance includes where you purchase a newly built or substantially renovated property, for which no one was previously entitled to a deduction for the decline in value of the depreciating assets, and either:
No one resided at the property before you acquired it, or the depreciating assets were installed for use, or used at this property, and you acquired the property within six months of it being newly built or substantially renovated. Following ATO guidelines on the ‘effective life’ of the asset, your accountant will typically claim depreciation of the fixtures and fittings in a new property such as carpets, window blinds, oven and hot water system etc. over 5-10 years.
This is a significant deduction and since 1 July 2017
is only available on new properties
or substantially renovated ones
This policy change is an example of a targeted change to the tax system to influence the allocation of resources and to encourage investment in new properties given the employment and welfare effects of new construction.
Think of how significant and beneficial new housing starts will be to the recovery of the economy post-COVID-19. The government will be encouraging new builds, which via the multiplier effect will contribute significantly to production, employment and incomes in the construction industry and the retail sectors.
Update as of 4 June: “The Federal Government will give eligible Australians $25,000 to build or substantially renovate their homes, in an effort to boost demand in the construction sector and keep builders employed.” ABC News
Brand new properties are often part of master-planned estates with attention to open space and attractive streetscapes. Consistency of housing and covenants (building and design guidelines applicable to a new estate) means that it is unlikely you will end up next to an ‘eyesore’!
New property normally requires minimal maintenance with no renovation expenses. The building carries mandatory warranty periods as do the new appliances installed in the property.
A new property is appealing to tenants.
New properties are built with changing demographics and trends in mind, enhancing the market appeal for tenants and on resale. For example, the trend towards open-plan living is making outdated the formal living areas that don’t match changing lifestyles and preferences. Changing family compositions can be deliberately catered for in new designs. Duplex and dual-key designs are catering to the growing demand for accommodating elderly family members as an alternative to assisted living options.
Consider the impacts on the workforce as a result of work from home orders. Prior to the pandemic, only 5% of workers were in home offices. During COVID-19 it increased to 45% and the new normal is expected to settle at around 15%. This is an example of a structural change to the way we work. The suburbanisation of work will have flow-on effects for the demand for housing in middle to outer ring suburbs and well resourced regional areas. It will also influence the design of housing.
The home office space will be a priority for many. New builds afford the opportunity to meet the changing demands of work expectations and arrangements. Then consider the rise in homeschooling and the need for separation and quiet. Some new multi-dwelling constructions are providing dedicated, communal workspaces for residents to access away from interruptions and the demands of family or other cohabitors.
If the property is a house and land contract to be built, stamp duty is only paid on the value of the land and not on the contract price. This offers the investor considerable savings. There is, however, interest to be paid on the loan during construction. This, combined with the stamp duty on the land, can equate to stamp duty on a completed package. Both of these costs can be offset against any capital gains tax liability when the property is eventually sold.