How ALP’s negative gearing plan will hit property, equities

As debate rages over the ALP’s plans to change negative gearing, investors are certain: it’s bad news for property and shares.

Apartment Towers in the inner Suburbs of Melbourne. Picture: Andrew Tauber

As the public policy debates rage over the ALP’s plans to change negative gearing, there is little to debate among investors: it is bad news for property and shares.

Many people don’t even realise you can negatively gear shares, but in fact it is an $11 billion sector that effectively will be terminated under the ALP plan, affecting about 80,000 people.

But with more than 1.2 million people using negative gearing on property, you can see why the potential hit on house prices is the outstanding issue.

To summarise the ALP plan as it affects property, negative gearing will no longer be allowed on existing properties, but it will still be allowed on new properties.

On top of this change, the ALP also plans to cut what is known as the capital gains tax discount. At present, if you sell an investment property you own for more than a year you get a 50 per cent discount on capital gains tax. Under the ALP plan, the discount will be cut to 25 per cent.

The changes will be grand­fathered — that is, they will only affect people who invest in existing property after the changes begin. If you already own a property, you can keep going as you were.

If you are an investor you don’t need an economic model to know that the values of investment properties will be lower if the next buyer of your property does not have the tax advantages you have earlier accessed. Similarly, if the discount is reduced on your tax bill, your potential profit on a property will go down.

rolling quarterly change in dwelling values

You might think that investors, knowing these changes are on the way, would be rushing into the market now before the curtain falls. But there is little evidence of this so far. Of course, house prices are falling at present and it takes some fortitude to buy in falling markets, but the most likely reason bargain hunters are thin on the ground is because there is a credit freeze. Investor lending among the banks is now running close to zero — you can’t get a loan unless you present exceptionally attractive numbers to a bank.

The ALP plan does allow negative gearing to continue in the limited area of new housing. The vast bulk of negative gearing is on existing property, but the ALP believes leaving negative gearing in place for new property will help formation of housing stock.

This is a pipe dream. Investors do not buy in housing estates at the edge of cities and they are unlikely to ever do so.

However, newly built townhouses in the inner and middle ring of metropolitan centres will in the future occupy a privileged place — they will offer tax breaks to investors. Those investors will of course find themselves selling “existing properties” down the track to buyers who can’t access the tax advantages in place just now. The sellers will also face higher capital gains tax bills. Nonetheless, it is a new area for some investors to examine if the election moves the way the way the polls suggest.

Negative gearing shares

Borrowing to buy shares and using any losses as a deduction against taxable income was common practice prior to the global fin­ancial crisis. Financial advisers would regularly recommend negative gearing as a strategy for long-term investors with high salaries looking for tax breaks.

However, the ALP plan dis­allows using investment expenses against taxable income, effectively putting an end to a practice.

At the peak of the last market cycle, about $41bn was lent each year to sharemarket investors, mostly though margin lending. That number had been stable at about $11bn for the past four years.

Under the new rules, investment expenses will only be allowed to be set against investment income, including capital gains. Of course, those capital gains will be subject to a higher rate of tax with the reduction of the 50 per cent discount to 25 per cent (for shares held for more than a year).

Andrew Green, chief executive of the Stockbrokers and Financial Advisers Association, says: “The abolition of negative gearing on shares means investors will require a higher nominal rate of return for the risk of negative returns. We should be encouraging, not discouraging, capital formation.”

Analyst John Carver at Investment Trends says the type of investors who use negative gearing arrangement for shares are long-term investors, not traders.

“Investors who use margin lending see themselves using the service for many years to come, with 62 per cent saying they intend to continue using margin lending for five or more years, and a further 18 per cent saying they will continue until they reach a specific wealth or savings target.”

New research from Investment Trends suggests that investors using negative gearing for shares had been getting younger.

A report due to be released in the coming days from Investment Trends suggests: “At present, the use of gearing to invest is highest in the late-accumulation stage, with 16 per cent of online investors aged 35-50 and 19 per cent aged 50-64 using gearing, compared to 5 per cent of millennial investors.

“There is substantial interest among millennials, with 52 per cent saying they would like to — or can be encouraged to — begin using borrowings to invest.”

But millennials — or anyone else — can forget about negative gearing if these changes occur.