ACOSS boss Cassandra Goldie will hold Joe Hockey to his word that "nothing is off the table" for tax reform. Credit:Tomasz Machnik The ACOSS report said that over half of the benefit of "negative gearing" deductions goes to the top 10 per cent of personal taxpayers, earning more than $100,000 a year. It also pointed out that more than 90 per cent of investor borrowing is for existing rental properties, not new ones, so investors are bidding up home prices without adding much to the supply of housing. "The large-scale use of these tax schemes not only threatens public revenue and faith in the fairness of our tax system," the report said. "It also reduces the efficiency of investment by encouraging people to invest with tax avoidance in mind rather than to achieve the best return at the least risk. It destabilises the economy by encouraging people to borrow more than they otherwise would and adding fuel to booms in asset prices – which are often followed by recessions." The recent financial system inquiry by former Commonwealth Bank chief David Murray noted that tax concessions such as negative gearing and capital gains tax concessions had fuelled household borrowing and posed a risk to the financial system.

Mr Murray has himself suggested that the negative gearing system be changed to a "neutral gearing" system, so that people no longer borrow above their means. But Treasurer Joe Hockey has indicated that changes to these tax breaks are unlikely, despite them being identified in the recent discussion paper on tax reform. ACOSS chief Cassandra Goldie said she would be holding Mr Hockey to his word that "nothing is off the table" in terms of tax reform. The ACOSS report suggests that existing investments be grandfathered. That would mean that people who bought an investment property before January 1 2016 would still be able to claim deductions under the existing rules until they sell the asset. If they buy an additional property after that, or are a new investor, they would come under the new rules it proposes. This, it suggests, would protect investors who have made decisions under the existing rules and have factored in tax deductions they could claim when purchasing the property.

Such a change, ACOSS estimates, would save $1 billion in 2016-17. But it said that this would rise in later years, as more new investments are made. "We firmly have the view that areas of negative gearing and CGT are important for reform," Ms Goldie said."They're over-generous arrangements ... at a time when we have a housing affordability crisis in Australia, and we should be instead using the tax system to drive investment in affordable housing stock." Currently, if a property investor spends more on interest payments and other costs, such as fees and maintenance, than the rent received, the investment is treated as a loss for tax purposes. This loss can be deducted from other income, including wages and money earnt through other investments such as shares. If the property also accrues a capital gain in that year, this is not taken into account at tax time. Capital gains are only taxed later, when the property is sold. "So the problem is not the ability to deduct investment losses against other income," Ms Goldie said. "It's that not all of the income is being taken into account each year. The problem is a combination of the tax treatment of capital gains and negative gearing."

An example is where a person bought a rental property for $500,000 with an annual rental return of $20,000 (or $400 per week). Their annual running costs (maintenance, agents fees, etc) added up to $5000 and the investor uses a more expensive "interest only" loan, for which the bank allows them to make higher (or lower) payments each year, to ensure that the investment makes a "loss". They then pay $40,000 interest and their total costs are $45,000. Given the income they get is only $20,000, they make a paper "loss" of $25,000. The investor deducts this against their wage, which in the case of someone on $150,000 ends up being almost $10,000. If the property value in that time increases in value by 5 per cent a year, instead of making a "loss" of $25,000 the investment actually breaks even. But the capital gain is only "cashed in" or realised when the property is sold. To stop people claiming deductions against investments which aren't actually making losses, ACOSS proposes that the deductions are quarantined so they can only be offset against the same investment. The $25,000 cash "loss" is instead carried forward until the investor makes a cash profit. This could be in a few years time as interest payments fall and rent rises; or it could be once the property is sold, in which case it is deducted against capital gains tax. This is essentially what the Hawke government did in 1985. The change resulted in house prices diving in some capital cities. But Ms Goldie said it was a myth to suggest that the change saw prices plummet across the nation and destroyed the industry. The claim that prices would fall was one Mr Hockey recently made on Q&A's program, before it being dismissed on the program by Grattan Institute CEO and economist John Daley as incorrect.