Debt Investing Property

REVIEW: Negative Gearing Explained – A Profitable Strategy?

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What exactly is negative gearing and how can it be used as a profitable strategy for property investors?

Definition:

A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings source ATO

Property Income – Property Costs = Loss 

Negative Gearing Explained

The best way to explain negative gearing, is straight from the horses mouth – i.e. the Australian Tax Office (ATO):

Definition continued:

The overall taxation result of a negatively geared property is that a net rental loss arises. In this case, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income (such as salary, wages or business income) when you complete your tax return for the relevant income year. Where the other income is not sufficient to absorb the loss it is carried forward to the next tax year.

If by negatively gearing a rental property, the rental expenses you claim in your tax return would result in a tax refund, you may reduce your rate of withholding to better match your year-end tax liability source ATO

Loss – Taxable Income = Reduced Tax Bill

Property Investment

If you are looking to buy a property, chances are you will need a mortgage to help fund the initial purchase.

Many investors also use loans to purchase property investments.

CHART: As you can see the number of investors who own property has risen over time, so to the percentage of property investors using loans.

negative-gearing-property-investor-growth-and-use-of-debt

 

CHART: The light shaded blue represents the property investors using borrowing according to age group.

negative-gearing-property-investors-by-age-and-debt-level

How Many Investors are Negatively Geared?

It is difficult to get the actual number of individual investors who are negatively geared, however we can source the overall figures.

In recent years the statistics from the Australian Tax Office (ATO) have shown that property investors on a whole are negative geared.

In other words property investors in Australia are claiming more deductions on their investment proprieties than income i.e. they are negatively geared.

CHART: Expenses claimed for investment properties over time, as a percentage of gross rental income

negative-gearing-property-investors-as-a-total-are-negatively-geared

Income vs Costs

The main source of income from an investment property is rent, while the costs can include:

Investment Property Expenses Include:
  • Interest on borrowings
  • Accounting fees
  • Advertising rentals
  • Bank charges
  • Council rates
  • Gardening
  • Government charges
  • Insurances
  • Land tax
  • Postage
  • Property management
  • Repairs & Maintenance
  • Water Rates
  • Other

Depreciation: It is also possible to deduct the cost of the wear and tear on the property and its fixtures and fittings. Depreciation is calculated according to a defined formula. Depreciation is a non-cash item, meaning you don’t physically have to pay the expense each year, but you can be sure at some stage you will have to renovate and repair the property and this will cost money.

Positive Geared Property

Positive gearing means a property investor earns rental income that pays for all costs of the property.

The best way to demonstrate the difference between negative gearing and positive gearing is using a case study.

Case Study: Negative vs Positive Gearing

Negative Gearing - Moneysmart

Source: Moneysmart.gov.au

How Do You Make Money?

Good investors will never invest for a tax deduction alone. A good investor will use negative gearing to help fund the holding costs of the property, with an expectation at some stage in the future they will start making money:

  1. Rents will continue to rise, meaning eventually the property becomes positively geared
  2. Eventually the property is sold and the investor makes money because the value of the property has increased.

Once you start making money, the tax man will start charging you tax – recouping all those previous deductions you claimed.

A good example of this is action can be seen from the first chart we posted.

Once investors reach retirement age (65 years+) they tend to use less borrowings as they would prefer to live off their investment income.

negative-gearing-retired

Summary

  • Negative gearing is a common strategy used in property investment.
  • You can offset the loss you make on your geared property against your other income (salary etc)
  • Negative gearing shouldn’t last forever, eventually your investment property will start making money and you will start paying tax

The Wealth Guy Signature

The information on this blog and website is of a general nature only. It does not take into account your individual financial situation, objectives or needs. You should consider your own financial position and requirements before making a decision. We recommend you consult a licensed financial adviser in order to assist you with this.

 

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