Pros and Cons of Negative Gearing for Australian Expats
Pros and Cons of Negative Gearing for Australian Expats – Australians have always had a love affair with property investment – whether it is buying a house to live in and start raising a family or going down the path of Rent-vesting.
Australians love property because well ‘ignorance is bliss’, we feel reassured knowing what we pay for a property, it’s a physical asset, and we only know what we make (capital gain) when we choose to sell it later in life. We don’t know what it’s actual value is until we sell it compared to holding a share portfolio, where we can see that assets value is changing every day.
A common strategy for property investing is negatively gearing your property portfolio. At present, there are 1.3 million Australians that own a negatively geared property. A negative gearing strategy is commonly used by both Australian residents and Australian Expats . However negative gearing for Australian expats is treated differently from a tax point of view and we’ll go into more detail on what the differences are.
What Is Negative Gearing?
This form of property strategy has become increasingly popular since the 1980s, and it allows an investor to deduct property expenses from their taxable income where they add up to more than what is earned from the rental income. Expenses which are tax deductible include interest expense from the mortgage, rates, insurance, property maintenance and depreciation on the property value.
Let’s look at a simple example of a typical Australian Tax Resident.
Say you earn $115,000 per year and pay $30,182 in PAYG tax. You buy an investment property which makes $35,000 in rental income per year and has tax deductible expenses of $50,000 per year. This, therefore, reduces your taxable income to $100,000., which would reduce your tax bill to $24,632.
Therefore, giving you a tax refund of $5,550, but still being out of pocket by $9,450.
How would this scenario play out for an Aussie Expat who is a non–resident for tax purposes?
Well, assuming the only Australian sourced income they have is the rental property, this would mean no PAYG tax has been paid due to them not being employed in Australia, and they would have a net income loss of -$15,000. This amount would be shown at label IT6 and carry forward to the next year. Accountants will usually refer to this amount as carried forward tax credits.
How Does Negative Gearing for Australian Expats Work?
Due to an Aussie expat not residing in Australia, this gives them the opportunity to accrue those net income losses each year and one day when they return they can use those income losses to offset their wage income in the first year or two depending on their salary level.
Lets put this into practice.
John is an Australian Expat who purchases an investment property in July 2015. The property produces the following net income losses:
- 2016FY -$14,500
- 2017FY -$13,875
- 2018FY -$13,125
John has no other Australian sourced income and returns to Australia to work in July 2018. John has an estimated wage income of $155,000, with PAYG tax of $44,982 for the 2019FY. When John lodges his 2019FY tax return, he uses the $41,500 in net income losses to reduce his taxable income to $113,500 which means Johns actual tax payable has been reduced to $29,627 therefore entitling John to a tax refund of $15,355.
Is Negative Gearing for Australian Expats An Effective Strategy?
As you can see negative gearing ‘may be’ an effective tax strategy if you intend on returning to Australia and working to receive those large tax refunds from the ATO. However, it is important to note that Australian Expats do lose out on the 50% capital gain tax concession on investment properties.
The 50% CGT concession states that you may hold an investment, such as shares or an investment property, for a period of greater than 12 months and if you realise a capital gain from the sale of those assets we you can discount the gain by 50% therefore, only having to pay tax on 50% of the capital gain.
Now back on the 8th May 2012 the government removed this tax concession for foreign resident individuals including Australian citizen non-residents (Aussie Expats).
While non-residents do get the benefit of carrying forward those type of net income losses (if the property is going up in value while they live overseas) however this capital gain which can’t be discounted when they sell the property later in life.
If the property has been owned for periods of residency and non-residency, then relative apportionment can be applied for the use of the CGT concession.
How Does the Labor Party’s Proposed Changes Affect the Strategy of Negative Gearing for Australian Expats?
Recently the Australian Labor Party (ALP), announced its proposal to change negative gearing as well as change the Capital Gains tax concession. The below has been extracted from the ALP’s website:
“Labor will limit negative gearing to new housing from a yet-to-be-determined date after the next election. All investments made before this date will not be affected by this change and will be fully grandfathered.”
This will mean that taxpayers will continue to be able to deduct net rental losses against their wage income, providing the losses come from newly constructed housing.
From a yet-to-be-determined date after the next election losses from new investments in shares and existing properties can still be used to offset investment income tax liabilities. These losses can also continue to be carried forward to offset the final capital gain on the investment.
We can interpret the above as follows. If the new proposal is enacted, the current property portfolio’s will be grandfathered under the old rules as of a specific date. Meaning we can still claim negative gearing against our wage income, as well as offset other investment income with our current portfolio.
Going forward only newly constructed properties will be able to be used for purposes of negative gearing against our wage income and existing properties purchased after this date that are negatively geared can only be used for offsetting other investment income and reducing a capital gain if we have accumulated carry forward income losses.
What Does This Mean for Properties Used for Negative Gearing for Australian Expats?
Labor will halve the capital gains discount for all assets purchased after a yet-to-be-determined date after the next election. This will reduce the capital gains tax discount for assets that are held longer than 12 months from the current 50 per cent to 25 per cent.
All investments made before this date will not be affected by this change and will be fully grandfathered.
This policy change will also not affect investments made by superannuation funds. The CGT discount will not change for small business assets. This will ensure that no small businesses are worse off under these changes.
Again we can interpret the above as follows. If and when this proposal is enacted it will cover all asset classes(property, shares, managed funds & LIC, etc.). Everything purchased before this date will be grandfathered to the old rules, and everything acquired after can only benefit from the 25% CGT discount method.
However, it is important to note this will not impact Superannuation or small business concessions.
Bad News for Australian Expats
If both these proposals are enacted, the argument can be made that investment properties for Australian Expats may no longer be such a sound strategy especially when you can look to other assets classes where no CGT would accumulate with the Australian Taxation Office, depending on the time of purchase.
Time might be running out to benefit from such grandfathering, as little is known about when the commencement date of such items would be implemented.
Moving forward it is important to understand whether or not negative gearing for Australian expats is right for your situation particularly if you are contemplating a new purchase or reviewing your own current portfolio.
It is always recommended that you seek advice from a qualified Financial Planner and registered tax accountant to make sure you are doing everything correctly.