The Benefits of Negative Gearing

What is negative gearing?

To understand negative gearing, it is best to get back to basics. Gearing means to borrow money to make an investment and investors tend to positively, negatively or neutrally gear properties. Positively geared properties are when the rent you earn exceeds amount of interest and outgoings payable. In other words, you make a profit.

Neutrally geared is where the rent equals your interest payments and outgoings.

Negative gearing is where your rental income doesn’t cover the cost of repayments and outgoings and you need to supplement from your salary or other income in order to meet your financial obligations for loan repayments and upkeep of your property. This is considered making a loss.

The benefits of negative gearing

In short, you don’t pay tax on a loss, and when it comes to negative gearing, you may even be able to offset that loss against your income, thus reducing your taxable income. For those on a reasonably high tax rate, negative gearing can be a positive thing.  You can even claim on the depreciation in value of improvements made to the property whilst it is being rented, such as a new kitchen, or renovations.

Expenses you can claim

  1. Your borrowing costs – the administration costs to set up a home loan
  2. Interest payments – because only interest repayments, not principal are deductable, many investors choose interest only loans.
  3. Rates – Council and water rates
  4. Repairs and Maintenance – includes pest inspections as well as repairs made while the property is tenanted.
  5. Building and renovation construction costs – must be while property is tenanted or advertised for rent.
  6. Insurances – Landlords insurance on the property
  7. Body Corporate and Strata fees – for units, apartments or townhouses
  8. Bank Fees
  9. Land tax
  10. Property management fee
  11. Cleaning expenses
  12. Gardening and lawn maintenance

Who benefits the most from Negative gearing?

Negative gearing is best suited to investors on a higher tax rate who stand to benefit the most from tax deductions (which are calculated on your marginal tax rate). The higher your tax rate, the bigger the benefit.

Negative gearing is also suitable for those who ultimately want to achieve a capital gain (a profit when they sell) rather than rental yield (income from renting your property). Low income earners or those seeking to make an income through rental are better to consider positive gearing.

A loss on paper but cashflow positive. How does that work?

Achieving a virtual loss but a real gain is the holy grail of property investing. To do that, you need to be across all the tax-deductible depreciation allowances, or have a financial adviser. The newer your property, the better the depreciation allowances, as they are calculated on the declining value of new items year on year, and capped at a specific time period. While they don’t actually cost you money, the decline in value on paper can make a massive difference to your tax return.

Real example

Imagine you have $15,000 in costs for your investment property, but only $10,000 in rent, you have made a $5,000 loss for the year. On a tax rate of 47%, you would get a benefit of $2,350 by offsetting your loss against your income, but on a tax rate of 19% you would only receive $950 in deductions.

Now, if you added in depreciation costs, which are simply declining value of new fixtures and not a tangible cost, of $8,000 on a new property (bringing your total losses to $13,000) the benefits for the higher tax bracket investor jumps to $6,110 compared to only $2,470 for the lower tax bracket.

Effectively the higher income earner has come out $1,110 in front once depreciation has been added in, while the lower income earner is still $2,530 behind after the initial tangible loss of $5,000.

It can be confusing, but if you are on a high tax rate, and looking for a long-term capital gain on your investment, it is worth speaking with a financial adviser to establish whether property investment would be right for you.

Posted in Latest news, Manage, Rent on 16th July, 2019