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A breakdown of Labour’s proposed policy to shut down a ‘speculation tax loophole’.

Recently, the Labour Party announced their policy regarding what party leader Andrew Little referred to as ‘Negative Gearing’ tax breaks for property investors.

Described as shutting a ‘speculation tax loophole’ this announcement has created a lot of confusion amongst both property investors and non-property investors alike.

What actually is negative gearing?

The term negative gearing simply means that the property is running at a loss.

That means the costs of interest, rates, insurance, property management fees, repairs and maintenance etc is less that the rental income that is coming from the property creating negative cash flow. In other words, the owner needs to ‘top up’ or subsidise the rental income.

This situation is not so common now with interest rates being low but is prevalent when rates are higher and especially for investors who have borrowed most or all of the purchase price of the property.

When a property suffers a loss, the owner may be able to offset this loss against their personal income.

This is what the Labour party is proposing to stop.

Currently for example, if the loss on a property is $5,000 in a financial year, the owner may be able to reduce their taxable earnings by $5,000 and therefore qualify for a tax refund if they are on PAYE through a salary or wage. Or if they are self-employed their tax liability will be reduced by $5,000 because of the loss being carried over from their rental property to their personal name.

To claim the loss against personal income the property must be owned in personal names or in a Look Through Company, (not through an ordinary trading company or a Trust.)

Under the Labour party proposal, the rental property would essentially be an entity of its own as the losses could not be offset against personal income but would rather be held or ‘ring-fenced’ by the individual property.

The owner would, therefore, be unable to claim back any of the funds that they had contributed to the property from their own pocket.

What Labour think this policy achieves

According to Mr Little, this will create an extra $120 million a year for the Government which will be recycled into other housing policies, notably subsidies for insulating homes.

It’s Labour’s hope that this policy will help first home buyers compete with investors who currently “exploit the legal tax break to get an advantage over potential owner occupiers”.

What is this policy likely to achieve

There is speculation though that the policy will:

  1. Achieve nothing for first home buyers who will still have to come up with a 20% deposit to buy a property
  2. Increase rents as rental property ownership will become less affordable for some landlords.

The Labour Party’s statement that they are shutting a ‘speculation tax loophole’ is the bit that baffles me. My understanding is that owning and running a rental property is a business like any other and that a business only pays tax if it makes a profit. If it makes a loss, that loss will reduce the owner’s overall income and therefore their tax liability.

The overall impact on rental property buyers

If the losses are unable to be offset against personal income it will no doubt have some effect on people buying rental property but probably not nearly as much as the 60% LVR restrictions that have already been put in place.

It certainly means that we are in for an interesting Election this year where the housing issue is being seen by many as the crucial one and more important than even health, education and the economy.

DisclaimerIt is not my intention to provide any tax advice in this article and all readers should seek advice from a duly qualified tax consultant for such matters