The Road Ahead : December 2015
RACQLIVING.COM.AU 26 THE ROAD AHEAD DEC 2015/JAN 2016 LIFESTYLE | DOLLARS+$ENSE NEGATIVE A POSITIVE TAX REFORM IS back on the agenda with some groups calling for the abolition of negative gearing. They are on the wrong track. Australians who are using negative gearing to increase their wealth are not millionaires flouting the tax system – most of them earn less than $80,000 a year and are only buying a single investment property. Let’s think about a typical couple who have secure jobs and earn $80,000 a year each. They are 50, have paid their house off, and are well aware there’s unlikely to be much of a pension available to them when they retire. The options available to them are cash, property and shares. Cash is particularly unappealing, with rates at historic lows and likely to fall further. They are terrified of shares and are becoming increasingly wary of super, due to the barrage of calls to change the rules yet again. The only option left is property. They are not interested in non-residential property, where vacancies of a year or more are common, so their choice of asset to build a portfolio for their retirement is residential real estate. They decide to borrow $450,000 at TAX REFORM IS TAKING THE WRONG TRACK IF IT ABOLISHES NEGATIVE GEARING. 5%, secured by a mortgage over their existing home, to buy a property for $450,000. Repayments of $3560 a month will have the property paid off in 15 years when they want to retire. In Year One, the net income from the property will be $18,000, and the interest for the first year on their loan will be $22,500. Hence, they are negatively geared to the tune of $4500 and should qualify for a tax refund of around $1250 each when depreciation allowances are taken into account. The total cost to the taxpayer is just $2500 – hardly the stuff that grand tax schemes are made of. Now fast forward to Year Five, when their net rents are likely to have increased to $21,000, while their loan is down to $339,000. Their interest deduction for the year is just $16,950 so they are now positively geared. By the time they get to 65, the debt should be paid off and the property could be worth $670,000, assuming capital growth of 4% per annum, and producing rents of $24,000 per annum, assuming annual increases of 3%. Let’s hope by now they’re feeling better about their employer-paid superannuation, because they’re going to need it. They’re well outside pension eligibility, but the rents from the property probably won’t be enough for them to live on, particularly with increasing maintenance costs as the property ages. Once they exhaust their superannuation, they’ll be forced to sell the house to provide enough funds to live on. This will certainly generate a hefty capital gains tax bill. Let me stress that this is not the kind of strategy I recommend – I much prefer the flexibility and growth potential of a diversified share portfolio. However, the couple in question are typical of many Australians in their tax bracket. Instead of being attacked, they should be commended for trying to be self-sufficient, and for the substantial contribution to taxes they will make in the future. STORY NOEL WHITTAKER Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance. His advice is general in nature and readers should seek their own professional advice before making any financial decisions. Email: email@example.com.
February March 2016