Are there tax arbitrage opportunities in private rental housing markets?

Tax arbitrage opportunities in rental housing markets arise when high bracket taxpayers exploit the tax shelter and conversion features of the tax treatment of rental housing and as a consequence offer low bracket taxpayers rental housing at a cost lower than if they purchased the same quantity of housing for owner occupation. A microdata set has been employed to estimate the size of these tax arbitrage opportunities with respect to 1907 properties owned by Australian landlords. The measure of tax arbitrage opportunities is the breakeven tax rate at which the maximum rental rate a potential occupant is prepared to pay before turning to purchased housing is equal to the landlord's reservation rental rate. Potential occupants with marginal tax rates below the breakeven tax rate find that renting has a relative cost advantage over home purchase. When agency costs (the costs incurred in managing landlord-tenant relationships) are included in the tax arbitrage model, our estimates of the breakeven tax rate indicate that home purchase has a relative cost advantage over renting for most potential occupants. Renting is only financially attractive to low tax bracket individuals. This finding is consistent with Australian tenure patterns. However, there are more puzzling results. A majority of landlords belong to tax brackets below the top bracket, landlords in the lowest tax brackets typically make below normal profits, and reservation rental rates at the bottom of the rental housing market are relatively high. Down payment requirements, lock-in effects, and rent clientele groups are put forward as possible explanations for these findings.