Are negative gearing and capital gains tax discounts sustaining your investment success?
An investment success contributor for many ‘ordinary’ Australians, is found in the taxation regime. It is enshrined in both tax legislation, and in settled Case law. Two key areas are:
- Negative gearing deduction; and
- Capital Gains Tax discounting.
From an economic standpoint, housing affordability and first home owner participation should be considered a distraction. Whilst the subject of popular debate the politicisation of these emotive issues is unfortunate. (We note with interest how these matters become more ‘heated’ near Federal election times in Australia.) There is no evidence that these tax law applications cause the outcomes attributed to them in such debates. If they were proven to be a cause of those problems, should they be removed from the law in any event?
It is apparent that these provisions in tax law and practice are important aspects of how our economy works.
Negative Gearing as an investment success contributor
What is negative gearing?
Negative gearing is a popularly-adopted term only, not a matter of statute. When interest costs of borrowing to invest exceeds taxable income from that investment it is said to be ‘negative gearing’.1
Hence, we can say that negative gearing is borrowing that results in a negative financial outcome – a loss of revenue.
Provisions in Australian taxation law allow taxpayers to have certainty about the cost of the investment risks they undertake. In return, legislators and the Taxation Office , expect these investments to eventually return a positive contributor to the economy. No doubt, investors also look to this eventual point of success. (Legislators represent the interests of the community that elects them. The ATO supervises the application of the legislation as it is intended.)
Tax deductibility benefits
The tax deductibility of interest paid on geared investments encourages entrepreneurs to take a risk to invest in business assets. These assets include plant, equipment, intellectual property – and real property, acquired to achieve their investment strategies. These are the active investors.
Passive investors in these business operations, are ‘shareholders’. They too can participate in the benefits of tax concessions, provided there is a realistic expectation of a taxable return. (In simple terms, investment into a rental residential property is considered a passive investment.) Accordingly, taxation through negative gearing deduction for interest and related expenses, is a vital investment success contributor.
If this aspect of taxation law is removed, there would be a significant, if not devastating, impact on our economy. Companies such as BHP, Telstra and ‘the Banks’ would all be much smaller businesses, as would the Australian economy.
In a political experiment in the 1990’s, removal of the negative gearing deduction for property investors, removed an important source of supply of investment homes with a reasonable rental opportunity for families unable yet, to afford their own home.
Capital Gains Tax discount as an investment success contributor
How does Capital Gains Tax (CGT) fit into this debate?
CGT became a matter for taxation law in 19852. Prior to that time there were substantial Court cases fought over whether particular transactions were either ‘capital’ , or income/ revenue. ( These were important Tax Law Cases given that –
- Capital is generally free from income tax, whilst
- Income (revenue) is generally subject to taxation.
In this context, we concentrate on the effects of the taxation law on the investor. Whilst CGT has implications for business operations as well, they are somewhat more complex – and in the main, irrelevant to the discussion of the effects of this law as an investment success contributor.
The application of the CGT has undergone some iterations: between 1985 and 1999, the ‘capital gain’ on any ‘property’ (and that has its own definition) that was sold after having been held for at least twelve months, was subject to a combination of an indexed cost base applied – and then a 50% discount from the gain, leaving the taxable amount of capital gain. Since 1999, a simpler – and some would argue, less generous – regime applies to the CGT discounts.3
Property as a tax-favoured investment
For those pursuing investment strategy success, property held for investment (that can’t otherwise be determined by the Taxation Office to be ‘traded’ property) is also subject to the CGT discounting regime. This applies equally to portfolios in securities (shares, managed funds, etc), as it does to investment real estate.
The implication of capital gain on the growth in value of investment assets as a contributor to investment success, is clear: if the gain would, but for the CGT legislation, be taxable, then the discount applied means that less tax will be payable and investment success more readily achieved. In some instances, the only opportunity for there to be a positive outcome from an investment, is to be found in the discounted gain.
If further tinkering with the taxation aspects of capital gains is to be considered, modelling of the effects of the changes need to be broadly debated and understood – and if to be implemented, those effects clearly explained to the investing public.
Is this only for residential property?
As much of the debate referenced in the opening paragraphs, is about residential property, are there investment principles that should be considered in relation to these taxation issues, relative to that market – particularly from an investment success standpoint?
A key factor to consider: investments should stand on their merits! The returns from the investment should be viable regardless of any taxation benefits (that may not persist for the term of the investment); and they should reward the level of risk taken with investing (and with residential real estate some of the detractors are – destructive tenants, periods of vacancy, unpaid rents; and change in market valuation because of economic conditions and/ or local zoning changes) .
How do you target investment success?
The experienced advisers at Continuum Financial Planners Pty Ltd can walk you through processes4 that will help you identify investment goals and develop strategies to implement – and we offer to review them under ongoing service arrangements. We will collaborate with your taxation adviser to ensure the investment success contributor is fully availed if your circumstances suit. To learn more about the advised experience our clients receive, meet with one of our Team: phone our office (07-34213456), or complete the Contact Us form (and be assured of a prompt, courteous response) to make the arrangements.
- We dealt with this matter in some detail in our article ‘Negative Gearing’.
- Of historical interest about the introduction of this ‘new’ head of taxation, is that it was brought on by the removal of Estate Tax (‘death duties’) at that time.
- Our article, ‘Capital Gains Tax’ deals in more detail with the current discounting arrangements – and the documentary requirements that are critical to establish your taxable position.
- Our Services Page outlines the process we follow: one that is applauded by peers and clients alike.
(This article was first published in February 2018; it has been occasionally refeeshed/ updated, most recently in August 2024.)
