This article was published on 14 February 2006. Some information may be out of date.

Views on negative gearing are poles apart

Negative gearing is like the death penalty. People feel strongly both ways about it, judging by reactions to my last column.

In that column, I wrote that negative gearing — which occurs when a landlord makes year-by-year cash losses on a mortgaged property — is becoming more common. This is mainly because rents haven’t risen nearly as fast as house prices.

I then pointed out that landlords who negatively gear for years might find it hard to dissuade Inland Revenue from charging them tax on their capital gain when they sell.

Such tax is payable if you bought an investment “with a purpose or intention of resale”. And if you don’t make money out of a property for much of the time you own it, why else would you buy it, other than to sell at a profit?

In a website discussion of the column, one person came up with another possible reason. If a negatively geared property gains in value, the person wrote, you can use that extra equity to buy more properties.

Okay. But if those new properties are also negatively geared, you’re still spending more than you make. Why on earth would you do that, unless in the end you sell at a profit?

Maybe the new properties would have positive cash flows. But probably not. According to one experienced landlord who emailed me, “In today’s property market it is virtually impossible” to buy a property with positive cash flow “without becoming involved in development, subdivision, etc.”

Another person on the website argued that if you are repaying principle and interest, every property will have a positive cash flow once the mortgage is paid off. True — usually, anyway.

Still, many rentals these days are on interest-only mortgages. And others might take many years to bring in positive cash flow, and many more before that income more than offsets all the years of outgoings — especially given that a dollar now is worth more than a dollar later.

If you are planning to hold on to a property until then, you may well escape tax on a final capital gain. Otherwise, I’m not so sure.

My concern, though, presumes that Inland Revenue will look more closely at rental property sales than it apparently has in the past.

Predictably, readers have varying views on whether that should happen. Negatively geared investors are of course opposed.

But, says one emailer, “The lack of enforcement of the law has been a disservice to the country as a whole because of the effects on inflation, first-home buyers who can’t afford to buy a house, and people like myself who want to invest for retirement income.” He owns five rentals with positive cash flow, and worries that, in attempts to “rein in” the property market, the government may introduce a tax on all property gains.

There are also widely varying experiences with negative gearing, ranging from one man who has “no problems at all with it” to a couple whose property “has been a major disappointment”.

But the award for not mincing words goes to one emailer. “Negatively geared property investors must have rocks in their heads,” he writes.

“This behaviour becomes very prevalent during periods of high capital gain, but provides nice opportunities for ‘real’ investors when the aforementioned are forced to sell in times of high interest rates and/or periods of low growth or declining values.”

It’s a fair warning. Negative gearers who can’t maintain their positions in the next few years might find that tax on their capital gain is the least of their worries — if they have to sell at a loss.

Mary Holm is a freelance journalist, a director of Financial Services Complaints Ltd (FSCL), a seminar presenter and a bestselling author on personal finance. From 2011 to 2019 she was a founding director of the Financial Markets Authority. Her opinions are personal, and do not reflect the position of any organisation in which she holds office. Mary’s advice is of a general nature, and she is not responsible for any loss that any reader may suffer from following it.