For years the term "negative gearing" has been synonymous with elections.
Labor promised to clamp down on it in the last election, and the Greens' policy for the forthcoming election is to "phase out negative gearing for people with two or more investment properties, and prohibit negative gearing for all new house purchases". The problem is the term is now effectively obsolete, as is the rationale to try to restrict it.
Gearing means borrowing. When you borrow to buy an asset and the outgoings exceed the income from that asset you have a negative cash flow from that asset. Hence the term "negative gearing".
Negative gearing was all the go in the 1980s. Interest rates on loans were 14 per cent, inflation was 10 per cent, and the top marginal tax rate was 60 per cent, which cut in when income reached $35,001.
Our tax system then was great for property and bad for shares. There was no capital gains tax then, but dividends on shares were effectively taxed twice.
Companies paid tax at 46 per cent, and then the shareholders paid tax again, at up to 60 per cent, on dividends that had already been taxed at 46 per cent. There was also an undistributed profits tax that penalised private companies who tried to retain profits for expansion.
Back then, anybody who wanted to create wealth faced quite a dilemma. If you put the money in the bank you lost up to 60 per cent in tax. If you worked overtime you lost up to 60 per cent in tax. If you tried to expand your business, or invest in shares, you got hit twice: up to 60 per cent in personal tax on top of 46 per cent in company tax.
But if you invested in property using negative gearing, you had it made. The top tax rate of 60 per cent meant that your interest got an effective government subsidy of 60 per cent, and when you eventually sold, the profit was usually tax free. Best of all, capital gains were almost guaranteed, as the population was growing and cities were expanding into new suburbs. The tax system virtually compelled people to invest in houses! Obviously, the system favoured high income earners, and contributed to house prices increasing.
In July 1985, in an attempt to level the playing field, the Hawke government took the bold step of placing some restrictions on borrowing for investment.
For all properties bought after that date, they disallowed a tax deduction for interest that exceeded the rents for the year, net of rates and maintenance deductions.
So, if a rental house returned $5000 gross and allowable deductions other than interest and depreciation came to $2000, only $3000 of the interest would be tax-deductible. If the interest cost was $4000, the un-deducted portion ($1000) could only be claimed against net income from the property in the future.
The property industry did some intense lobbying, claiming that the changes to negative gearing had caused investment in rental accommodation to dry up and rents to rise. So in September 1987, the government restored the old rules, once again permitting the deduction of interest and other rental property costs from other income sources.
It's a completely different world today: with low interest rates and reasonably high yields, negative gearing is almost impossible.
Think about a person earning between $45,000 and $120,000 a year. If they borrowed $500,000 at 3 per cent to buy a residential property for $550,000 with a net yield of 4 per cent, the cash surplus would be $7000 a year (ignoring depreciation allowances, which depend on the property purchased and are clawed back on sale anyway). It's not a tax advantage at all. There is no tax deduction; the investor has positive cashflow from day one.
Housing affordability is a massive problem in most developed countries, but there is no easy solution. Central banks created the problem by slashing interest rates to ridiculous lows, which effectively reduced the price of housing by enabling a surplus of buyers into the market.
Once housing prices started rising, fear of missing out kicked in and fuelled the boom. Governments exacerbated the problem with a series of incentives to homebuyers, which have pushed prices up even further.
Possibly the forthcoming rises in interest rates will make house prices start to fall, but one thing I know for certain: measures to discourage borrowing for investment won't make one scrap of difference.
Noel answers your money questions
I bought three properties for the negative gearing advantages and to set up my three sons for the future. They are now living in those properties and have families of their own. I have willed the properties to them- will they have to pay CGT on my death.
If you leave them to your sons your death will not trigger CGT - there will be no CGT payable until they dispose of them.
If they continue living in the properties the percentage of the gain exposed to CGT will decrease over time because a growing proportion of the property will be exempt from CGT under their main residence exemption once it is in their name.
However, a better option may be to transfer them to the children sooner rather than later because even though CGT would be triggered then in your name, the houses would then be exempt from CGT much sooner, as long as they lived in them. It's really a matter of asking your accountant to do the sums. Maybe transferring one property a year to minimise the impact and consider making superannuation contributions.
I'm in my early eighties and recently added a downsizer payment to my superannuation account which is in pension mode. The sum in total is well under the $1.7 m threshold. Is the downsizer amount treated exactly as is the other money with regard to mandatory annual draw-downs and taxation after my death?
Just be aware that there is no $1.7 million limit on how much can be accumulated in pension mode - it's the maximum that can be transferred to it. After you made the transfer it's fine if it goes above that.
The downsizer contribution is a non-concessional contribution and as such would not have been added to your pension account - it should now sit in a separate accumulation account. If you leave it there, which you are entitled to, you will pay 15 per cent tax on earnings within the fund but there will be no mandatory drawdowns.
If you decide to move it to pension mode it will become a tax-free fund with the required minimum drawdowns each year. The death tax applies only to the taxable component of your super left to a non-dependent. The whole of your downsizer payment would be non-taxable but its earnings will form part of the taxable component.
We are now 70 and have a daughter who is 42 and has lived with a disability. She is in the NDIS scheme and on a disability pension. She has never been in a superannuation scheme and has next to no savings. She has a four-year-old daughter.
We will leave her money in our will, which we need to rewrite, and she will inherit half of our house. Five years ago we took money out of our super and bought her a little house under the government shared equity scheme. How can we ensure that she does not lose her disability pension after we die?
Do we leave instructions to pay off her $30,000 mortgage on her house as well as buy out the government share? Then should we set her up in a superannuation scheme?
If we willed the majority of her inheritance into her super scheme and paid off her house would that ensure that she would safely get her disability pension until she was 55 or older ?
If the executor just puts her inheritance in the bank she is at risk of being exploited by others. We investigated a trust, but it was far too expensive to run. Fortunately she has an intelligent and caring brother, our executor, who would look after her needs.
Elder Lawyer Brian Herd tells me that this is a complex issue that cannot be adequately and confidently addressed without lots more information.
However, in very general terms, one of the effective ways to protect a disabled person in respect to preserving their pension and protecting them against being exploited, is the use of a Special Disability Trust.
The parents can set this up now while they are alive or in their wills.
If set up properly, it can ensure she gets the financial benefits of the trust and can keep her disability pension.
- Noel Whittaker is the author of Retirement Made Simple and numerous other books on personal finance. email@example.com