Negative gearing changes will be felt beyond housing

The truth is that negative gearing as an investment option has rarely been so weak as a wealth management tactic.

Governor General Peter Cosgrove auctions his Neutral Bay home today but failed to register a bid. It was expected to fetch over $2.1 million dollars. Picture: Toby Zerna

This week’s bombshell policy ­decision from the ALP to reduce the attractions of negative gearing — and to increase capital gains tax — comes just as investors were planning to add shares alongside property investments in leveraged portfolios.

A recently completed report from the Investment Trends consultancy found that alongside the huge participation in property ­investment — geared investors were returning to the sharemarket with the value of margin lending rising in the last 12 months and almost 100,000 ­investors planning to borrow for share portfolios this year. (Margin lending is the key vehicle to access negative gearing in shares).

The figures from the consultancy suggest negative gearing and CGT changes outlined by the ALP, and under consideration by the Liberal government, will affect more investors than currently estimated.

It also suggests that despite volatile markets, negative gearing remains a key wealth management instrument for many people: An estimated 67,000 investors used margin lending for shares last year, down 4 per cent on the year before.

Despite these signals of a ­renewed enthusiasm the truth is that negative gearing as an investment option has rarely been so weak as a wealth management tactic. That’s because just now it is very hard to make money using this method, with yields from both shares and property often approximating interest rates.

● The ALP says it will restrict negative gearing in property to new homes, and in shares there will be a change where negative gearing related allowances will only be allowed to be set against investment income: Currently you can set any allowances gained from negative gearing against your salary and your ­investment income combined.

● The Liberal Party has so far only criticised the ALP plan but there are strong rumours the Liberal government will either limit negative gearing through a dollar cap or a cap on the number of properties that can be negatively geared. Only a ­dollar cap would seem feasible — capping the number of properties would seem to be a very ineffective mechanism as properties vary hugely in price.

Of considerably greater importance is any move by either party to touch the current arrangements on capital gains tax.

The ALP plans to cut the ­current CGT discount by half — this is a huge change — it is also a little complex to understand, so if you want to figure it out read the next paragraph — if you don’t, jump forward here.

●At present if you sell an asset after 12 months, your capital gain is cut by 50 per cent, then CGT is applied at your marginal tax rate (for investors earning more than $180,000, the marginal tax rate is effectively 49 per cent. Therefore, the effective CGT rate is 24.5 per cent if an individual sells an asset more than 12 months after purchase). Under the ALP plan, the capital gain discount would be reduced to 25 per cent. Effectively this would lift the CGT bill on all asset sales such as shares, properties and other asset types. If the ALP plan gets through, those who sell more than a year after acquiring an asset (typical in property, common in shares) will find the 49 per cent bill is only cut by 25 per cent, meaning they will be charged a CGT of about 37 per cent.

For investors there are a range of contingent issues thrown up by the provocative ALP policy and the looming response we will get from the Liberal Party in the coming weeks — a response of some significance is required, but whether Treasurer Scott Morrison will go any further than “capping” negative gearing activities is impossible to fathom.

Here are the key factors for property investors:

● The “caps” idea seems quite feasible — there are precedents here, the “caps” in concessional superannuation contributions for example — and if it goes ahead there may be an upsurge in investment ­activity in residential property before the policy becomes law.

● There is some risk that rents may rise in residential property if investors are restricted to getting the full 50 per cent CGT discount only on new properties.

● If negative gearing is restricted to new property, new properties in the inner cities could see a price spike. In contrast, there is little evidence to say that investors will ever wish to invest in new housing estates on city fringes, even if negative gearing is left in place for these zones.

Here are the key factors for share investors:

● High-yielding dividend-­focused stocks will become more attractive than capital-growth ­focused stocks from a tax ­perspective.

● The potential rewards from leveraging into shares — already slim with low interest rates and high dividend yields — will ­dwindle.