Why negative gearing is not a fair tax policy

Interesting view from Antony Ting, Associate Professor at University of Sydney:

Is negative gearing in accordance with well-established tax rules? A fundamental principle in the tax law is that a taxpayer should be able to deduct expenses only if the expenses have been incurred to generate assessable income.

This is why an employee can only deduct expenses that are sufficiently related to work. For example, a funeral director at tropical Queensland would be able to deduct the cost of his black jacket (but not his black trousers) because the ATO believes that no rational person – except a funeral director – would wear a black jacket in such a hot place.

Should mortgage interest on an investment property be deductible? Investment properties generate two kinds of income: rental income and capital gains (if any). As capital gains on investment property can enjoy a 50% tax discount if the property has been held for at least a year, strictly speaking only 50% of the interest expenses related to the capital gain should be deductible.

……Many countries resolve this issue by quarantining losses on investment properties. It means that losses generated from negative gearing cannot be used to offset against other sources of income, for example, salaries or business income. Instead, the losses can be carried forward to future years to offset against income from the investment properties.

Quarantining losses seems fairer than limiting deductibility of losses to the 50% discount normally available on capital gains. But the situation gets more complicated when the property is sold. Can accumulated losses never be deducted against gains on other assets or should they be offset against any capital gain made on disposal of the property? And if the result is a net capital loss should this be allowed to be offset against gains on other properties? We need a system that is fundamentally fair.

Read more at Why negative gearing is not a fair tax policy.