Negative gearing may come back to haunt you
Many landlords say they don’t mind or even like to be negatively geared — making year-by-year cash losses on a mortgaged investment. But it never looked all that appealing to me. And recently I heard a rather compelling argument against it.
Negative gearing is becoming increasingly common. As house prices have soared, so have mortgages. Rates have also risen fast in some places, and insurance and maintenance costs rise with inflation. Meantime, with more and more landlords chasing tenants, rents are static or, in some places, falling.
Landlords who have the cash to cover the difference between outgoings and incomings are often confident they will make a big enough capital gain when they sell the property to more than make up for the extra inputs in the meantime.
What’s more, they can deduct the loss from other taxable income.
This last feature is over-rated. Even after taking the tax deduction, a $1,000 loss costs you $610, $670 or $790, depending on your tax bracket.
Also, rental property investors sometimes overlook the fact that they must cover the losses now, but they don’t get their gain until they sell the property.
A dollar now is worth more than a dollar later, not just because of inflation but also because you could earn interest on the money in the meantime.
I often wonder how much a negatively geared landlord might accumulate if she or he didn’t own the property and instead invested the yearly inputs elsewhere.
My new worry, though, is whether these landlords might find themselves paying tax on their capital gain when they finally sell their property. That would take a big chunk out of the gain, quite possibly turning a good investment into a bad one.
Why should negative gearing affect tax on gains?
While many people think that under our confusing law only people who buy and sell properties for a living have to pay the tax, that’s not true.
It’s not how long you own a property, or how many properties you own, that matters. It’s your main intention when you purchased. If you bought “with a purpose or intention or resale”, any profit you make is taxable.
People who invest in rental properties over long periods can generally say they bought with the purpose of getting a rental income.
But if you are negatively geared for many years of your ownership, it would be hard to make that case. Not only are you not getting income, but you’re paying out.
So far, I don’t think many people have been caught by this. It’s hard to know. Inland Revenue doesn’t publish figures, and I suspect that people who were caught might not tell the world about it. Making an investment mistake can be embarrassing.
Regardless of the current numbers though, there are two reasons why more people might be caught in the future:
- As I said above, negative gearing is becoming more common.
- The government keeps saying it would like to discourage property investment.
Without making any changes to the law, it could start to look at landlords’ histories when they sell their properties. If you’ve been claiming tax deductions for negative gearing over the years, that will be in your tax records.
Footnote: The fact that landlords don’t know where they stand on this tax is appalling.
I’ve never heard of another tax, anywhere in the world, that depends on such a woolly concept as people’s intentions when they buy.
The issue also arises for investors in shares. It needs to be clarified.
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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.