Have you fallen for these negative gearing myths?

Earlier this year, the tax setting – which last made headlines during the 2019 federal election – was reignited by Greens leader Adam Bandt’s push to abolish negative gearing in return for supporting the government’s Help to Buy scheme, and the subsequent backlash from Prime Minister Anthony Albanese.

It’s a topic that, for many Australians, can be emotionally charged. Amid the chaos, bold claims about negative gearing’s impact on the country’s present and future housing economy are frequently made – but, worryingly, these statements are often made without reference to independent academic research.

According to David Montani, national tax director at Nexia, today’s “political gridlock” has been decades in the making.

“I view it like the old Cold War concept of mutual assured destruction,” said Montani. “Each side has a ready-made, ready-to-launch set of dishonest scare campaigns.”

Against the backdrop of this heated conversation, we have turned to the work of economists and tax specialists to provide a more accurate and grounded counter perspective to some of the most prevalent myths.

Myth 1: Negative gearing is a tax concession.

Contrary to popular belief, negative gearing is not a legislated tax concession.

As Montani noted in a 2017 article, there is “no specific law enabling a deduction for a rental loss”.

Instead, the ability to deduct rental losses from personal income arises from the same 50 words “that allow most deductions”.

The Income Tax Assessment Act 1997 states: “You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a business for the purpose of gaining or producing your assessable income.”

In other words, it’s a lack of any exception to these rules that allows rental losses to be deducted.

According to Dr Hazel Blunden, senior research fellow at UNSW, this is “an almost uniquely Australian practice”.

Almost all other OECD countries – with the exception of Germany – quarantine rental losses to the asset class of residential property or restrict it in some other way, leading Blunden to characterise section 8–1 of the act as an “‘extraordinary’ tax rule” that “persists despite being out of step with international tax regimes”.

Myth 2: Removing negative gearing will cause rental prices to skyrocket. The 1980s proved this.

In 1985, Bob Hawke’s Labor government introduced legislation to stop landlords deducting rental losses from their personal income.

Instead, losses were quarantined to residential property, meaning that landlords could only deduct their rental losses from future rental profits.

In the two years that followed, rents in Sydney and Perth rose, and in 1987 the original negative gearing legislation was reinstated.

Today, the Hawke government’s experiment is used as a cautionary tale for those who want to meddle with the current tax setting. But is the story all it seems?

“In some respects it’s become mythologised,” Montani explained.

“The argument is that the quarantining caused investors to leave the market, reducing the supply of rental properties relative to tenant demand, resulting in rents rising significantly.”

But in fact, rents only rose in Sydney and Perth. In Brisbane and Adelaide, rents went down, while in Melbourne rents stayed the same.

Most likely, the rises seen in Sydney and Perth were local upswings in a normal vacancy cycle.

“There’s no clear pattern here, certainly no evidence of causation,” Montani said. “The suggestion is that really this was just a normal cycle of rents going up and down.”

This isn’t to say that quarantining has zero impact on investor sentiment.

Dr Mustapha Bangura from the University of Technology Sydney and Professor Chyi Lin Lee from UNSW conducted a submarket analysis in 2019 and found that reduced rental yields would cause some Sydney investors to leave the market.

Despite this, modelling suggests that the impact on rental prices would be relatively minimal.

A trio of University of Melbourne researchers – Dr Yunho Cho, Dr Shuyun May Li and Dr Lawrence Uren – found that “when negative gearing is repealed, housing prices decrease by 1.7 per cent while rents increase by 2.4 per cent”.

They found that the lift in rents would be largely offset by a corresponding rise in government transfer payments “funded by taxes collected by landlords”.

“The increase in transfers outweighs the small increase in rents,” they said.

Myth 3: Australia has always had a supply problem.

We aren’t building enough houses to keep up with demand.

It’s a statement that, in the property community, has been repeated so many times that it has transcended to the status of truth.

Population increase due to overseas immigration is widely claimed to be the primary reason behind this supply shortfall.

It’s certainly true that in 2024 we are not building enough houses to meet the needs of our growing population due to massive gridlocks in the construction sector. But house prices were rising steeply well before COVID-19, including during the mid-2010s, which was one of the most productive building periods in the country’s history.

“Between 2012 and 2016, dwelling starts in Australia rose from 153,000 to 228,000 per annum, a growth of around 50 per cent,” wrote Dr Isla Pawson, a Cambridge-trained Treasury political economist, in a 2018 paper.

At the time, she noted that dwelling completions in Australia were second only to South Korea, with two-thirds more new homes per 1,000 persons than the US and four times more than the UK.

“House construction has grown faster than population growth in Australia, and at a higher rate per new head of population than in the US or the UK,” said Pawson.

During the same period, however, the median Sydney house price rose from $555,000 in 2012 to $1.07 million in 2016.

“Record increases in supply have not served to dampen house prices or rents,” Pawson stated.

If construction kept pace with immigration, then why did prices rise so drastically?

The answer is an excess of unproductive investment in existing housing stock.

Montani noted: “93 per cent of property lending is for purchasing existing houses, which doesn’t add to the supply of housing.

“The vast majority of people buy an existing house, which, of course, does not add to supply because whoever you bought the house from now needs to go and live somewhere else. You’ve actually not achieved any net gain there.”

Investing in build-to-rent housing is different – this does actually create new housing stock. But, as it currently stands, this represents a very small percentage of private property investment.

As well as not adding to supply, Montani noted that investment in existing dwellings “artificially inflates demand for houses (as investments), fuelling speculative growth in house prices”.

“Of course, we all like to acquire assets that rise in value,” he said. “But residential property is different from other asset classes […] because not only is it an investment, it’s also where people live.”

Myth 4: Middle-income Australians rely on negative gearing.

Australia’s private market is dominated by small-scale operators – the proverbial “mum and dad” investor – but it’s a mistake to think that small-scale equals small-income.

Around the time of the 2016 election, then-treasurer Scott Morrison famously claimed that “two-thirds of those who use negative gearing have a taxable income of $80,000 or less”.

“They are modest income earning Australians, nurses, teachers, police,” said Morrison, who would later go on to become Australia’s prime minister.

However, independent studies by economists have almost universally found that high-income earners are “the major beneficiaries of negative gearing with the top 20 per cent of households taking about 50 per cent of the benefits”.

In 2016, only 8 per cent of people with taxable incomes below $80,000 used negative gearing, compared to 18 per cent of people earning over $80,000.

Regardless of individual income, one thing that’s always true is that claiming a negative gearing loss is a cushioning strategy.

Investors who choose to negatively gear their portfolios are making a choice to deliberately lose money in the short term, knowing that one day they will be able to cash in. These investors know they can afford the day-to-day hits to their wallet because they have enough cash to spare.

Montani explained: “Negative gearing is essentially borrowing so that you can leverage off into a larger investment footprint than you otherwise could.

“No rational person goes and loses a dollar to save x amounts of cents in tax and that’s the end of the story – it’s pretty obvious that’s a bad financial strategy because you’re left out of pocket.”

“In earlier years the borrowing costs exceed your rental income, but the idea is that in time eventually the property grows in value, the rental value rises, so you start clawing back your accumulated losses.”

Myth 5: Negative gearing has no place in an equitable housing future.

For opponents of negative gearing, it’s easy to paint this policy as antithetical to a fair housing future.

But a closer look at the international context reveals that changing negative gearing is rarely as simple as “it stays” or “it goes”.

In the 1980s, the Hawke government’s new negative gearing policy was “grandfathered”. This meant that it applied only to houses that were purchased after 1985, while all rental properties purchased before the legislation was passed were exempt from the new laws.

When New Zealand overturned negative gearing in 2021, the tax setting was abolished for future purchases only, and the government “put in place a five-year phase-out plan for existing leveraged property investment”, explained Bangura and Lee.

In Canada, landlords can only claim cash outlays as deductions, such as maintenance and repair costs. In France, there is a cap on how much money can be claimed as rental property deductions.

Meanwhile, in many countries, such as the US, negative gearing is quarantined to the asset class of residential property.

Given Australia’s ongoing need for more homes, many economists suggest that negative gearing deductions be prohibited for existing housing stock, but permitted for new builds and/or affordable housing.

Regardless of which path is ultimately chosen, any alterations to the current negative gearing policy will most likely take place alongside an array of wider reforms.

“The negative gearing debate, in my view, is a symptom of an underlying cause,” said Montani. “When you address the underlying cause, that requires addressing all the components of our tax system.”

“Our tax system is like a jigsaw puzzle with many different pieces. If you look at one piece of a jigsaw puzzle in isolation, it’s meaningless. If you bring all the pieces together, then a coherent picture forms.”

The takeaway

For those anxious about the impacts of changing current tax settings, these reality checks about negative gearing are good news.

The soaring rental hikes that many fear are unlikely to take place. Instead, if any alterations to negative gearing policies do occur, they will most likely take place within a wider context of changes that will work to incentivise developments that will meaningfully improve Australia’s housing economy and disincentivise practices that will not.

For some property investors, a change to negative gearing would mean a strategy switch-up. Investors would need to upskill and be proactive about their cash flow strategy, instead of relying on the market to do the hard work for them.

But with a wide range of investment options out there – from build-to-rent, to co-living accommodation, to commercial property – smart investors who choose to think clearly, instead of catastrophising, can still create a strong portfolio.

Montani observed that as things stand, Australia’s tax system has a long way to go.

“In 10 or so years, I’ll be joining the cohort of very lightly taxed retirees, and that will be balanced out by my children bearing the brunt of that,” Montani reflected.

“It’s not a good present, it hasn’t been a good past, and it’s not going to be a good future either.”

“I’m motivated by what will produce a better society and a better country, in all respects,” Montani said. “If you want to keep supporting and funding that, you need the tax system that’s going to do precisely that.”