Property investors are shaking in their boots after the Labor Party announced plans to limit negative gearing to new homes only.

And the scare tactics have begun too.

  • Rents will rise
  • The biggest losers will be the poor families trying to get into rental properties
  • Investors will change markets and tactics
  • Property market will be skewed towards buying brand new homes – which is not always the best investment strategy
  • An increase in dodgy property promoters
  • Labor will pay at the next election for this stunt

A number of property ‘advisers’, themselves heavily invested in negatively geared property, clearly don’t like the Opposition’s plan. (Negative gearing refers to the rental income being less than the expenses associated with property investing – and for individual taxpayers to offset those losses against their other income).

An estimated one in five taxpayers own at least one investment property according to Australian Tax Office (ATO) statistics, or around 1.9 million taxpayers, who claimed $42 billion in rental deductions for capital works, interest and other rental expenses such as repairs, council rates, and management fees in the 2013 financial year. That was partly offset by $36.6 billion in gross rental income, resulting in a shortfall of $5.4 billion.

Not all property investors claim negative gearing though – around 600,000 investors were either positively geared or neutral.

The problem for the Labor Party is that any change to reduce negative gearing is likely to be highly unpopular – not only because of the number of tax-paying landlords, but also ATO stats that reveal 70% of those claiming negative gearing had incomes of less than $80,000. Even worse, statistics show 32% of property investors have a taxable income of less than $37,000 a year.

NOTE: Part of the reason so many individuals with rental properties have low taxable incomes is that negative gearing creates a net rental loss – which is included in taxable income figures. In fact, according to the Australian Financial Review, around 64,000 negative gearers have taxable incomes of less than zero. If it were true, how did they manage to borrow the funds to buy an investment property in the first place?

And 72% of those individuals that owned an investment property own just one. Less than 1% of taxpayers own 6 or more rental properties.

Clearly, Labor’s proposed change to negative gearing and reducing the capital gains tax discount to 25% from 50% is designed to save the government billions annually. The Coalition is also expected to unveil their own changes to negative gearing (likely capping the number of properties that can be geared or limiting the annual deductions).

Either way, property investors – and those ‘successful’ property investors who now make a living from running expensive training courses to teach others how to invest in property – appear likely to be hard hit at some stage this year.

That comes after the banks were discouraged from lending too much to property investors and speculators by the regulator last year. As a result, a number of banks, including the big four of Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd (ASX: NAB) and Westpac Banking Corp (ASX: WBC) introduced lower loan-to-valuation ratios (LVRs) and higher interest rates for investment loans.

Foolish takeaway

Many activities currently subsidised by the government, including superannuation, medical benefits, medical prostheses, diagnostic imaging and pathology, and property investing are under the microscope as the government tries to reign in its spending, and recoup some revenue to balance its books.

While the mooted changes to negative gearing are unlikely to be retrospective, should they be enacted, it could see a plethora of property investors leave the market and weaker demand for investment property. We may see house prices fall substantially – and wreck further havoc on those property investors heavily negatively geared.

You have been warned.

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.