Not a time for tax losses and capital gain

Those hundreds of thousands of property investors making losses on their properties must be crossing their fingers that house prices keep rising.

Those hundreds of thousands of property investors making losses on their properties must be crossing their fingers that house prices keep rising.

Property investors claim billions of dollars a year in tax deductions on their loss-making properties.

Only about a third of those who report to the Tax Office that they have an investment property make money. It is mostly because of negative gearing.

This is when, if the rent does not cover the interest costs and other expenses, the shortfall reduces the investor's income on which income tax is paid.

Over time, rents do rise and these investors expect rents to cover the costs of the investment. But anyone losing money on an investment must be counting on decent capital gains when they come to sell down the track.

Earlier this year, Cameron Kusher from RP Data looked at the Tax Office's negative gearing numbers for the 2010-2011 financial year, the latest available. He found the average annual loss for these investors is about $210 a week, or just under $11,000 a year.

Large capital gains indeed would have to be banked on selling the property to cover these losses as well as other outlays such as stamp duty.

And then there is capital gains tax on selling. These investors have a lot riding on house prices lifting.

We had a price boom between 1996 to 2003, when house prices, in real terms, doubled. There is no doubt that many investors who geared in over that time made a killing. But the boom was mostly fuelled by leverage.

Starting in the early 1990s, interest rates fell from their double-digit levels. Low rates and the financial deregulation started in the 1980s got into full swing in the 1990s. It allowed investors to borrow more, and they did, to rev up capital gains. Since then, house prices, in real terms, have not done much.

However, the Sydney and Melbourne property markets are coming to back to life. During the past three months prices in both cities have risen by about 5 per cent. Auction clearance rates in Sydney are just under 90 per cent and almost 80 per cent in Melbourne. And investors are accounting for a big share of new mortgages, particularly in Sydney.

But anybody buying a property today as a loss-maker, relying on capital gains to make good, should be very careful. It is likely that too many investors place too much importance on the tax breaks from negative gearing. The Reserve Bank warned recently that it expects growth in house prices to be more in line with income growth than a repeat of the earlier price boom. With the cash rate and mortgage rates so low, the risk of playing property for capital gains is that in six months or a year, interest and mortgage rates may well be on the rise. Rising interest rates are not supportive of house prices.