Negative gearing is shaping up to be a contentious area of tax reform. It is a complex and highly political issue with significant revenue implications for the Federal budget outcomes.

In 2013-14, almost 1.3 million Australians had negative gearing. Some 300,000 people with taxable income less than $18,200 a year owned rental properties. Rental interest deductions amounted to $22.5 billion. Taxpayers claimed a total of $12 billion in tax losses from investment properties.

Negative gearing refers to the practice of borrowing to purchase a property for investment. It is negatively geared when the financing costs such as interest exceed the rental income from the property.

The taxation outcome of a negatively geared property is a net rental loss in an income year. Property investors are able to claim a deduction for the full amount of rental expenses and losses against their rental and other incomes such as salary, wages or business incomes when lodging tax returns for the relevant income years. Where the total income is not sufficient to absorb the loss, it is carried forward to the next tax year.

A number of proposals are currently debated to reform the taxation of negative gearing in property investment. Federal Treasury is reported to be considering a global limit for all deductions including those related to negative gearing, work, health, managing tax affairs and gift or donations. This will limit the total deductions to a proportion of income or an indexed ceiling, say 25% of income or a ceiling of $50,000, whichever is greater. Britain has a similar system introduced in 2012.

Using data from 2010-11, it was found that a cap of $50,000 or 25% of income would affect only 0.9% of property investors and only 1.3% of those incurring rental losses. A lower cap of $12,500 would affect 9% of landlords and 14% of those incurring a rental loss.

Another proposal being debated is to restrict the negative gearing only to newly constructed homes. No negative gearing deductions will be available for investing in existing houses. The measure is expected to save $32 billion over a decade. This will increase supply of rental properties, lessen upward pressure on house prices and provide a powerful affordability stabiliser for first home buyers. Under this proposal, the new regime will be operative as of 1 July 2017 and all existing negative gearing arrangements will be grandfathered or continue to be eligible for the current level of deductions.

Negative gearing may never be fully removed as it would have adverse effects on rental affordability. It was once removed from 1 July 1985 and then allowed back in September 1987, the removal was operative only for around two financial years. The repeal was due to the fact that investment in rental properties dried up, supply of dwellings for rent drastically reduced and property rents soared as a result. This badly impacted upon the ordinary Australians who could not afford to own their private place of residence.