Negative Gearing

Australian Residential Property Planners advisors are frequently asked how does negative gearing work and why is it so controversial in 2017. In simple terms negative gearing occurs when you borrow to invest in an income producing asset and the cost of borrowing exceeds the returns (income) from that asset.

Negative gearing for an investment property, for instance, occurs when the annual interest payable on the loan used to acquire the property plus other expenses incurred in maintaining the property, exceeds the annual rental income the property generates. Seen in more depth with this very nice Negative Gearing Calculator Your Mortgage but as always let your accountant give you the numbers at tax time.

Put simply, a Negative Gearing example is when:

  • You borrow to acquire an investment
  • The interest and other costs you incur are more than the rental income you receive from the investment (in other words you make a cash loss), and
  • This cash loss is offset against income from other sources, thus reducing your taxable income, and hence the amount of tax you have to pay (compared to the tax you’d pay without the investment).

In other words, with a negatively-geared investment you make a cash loss, but the effects of this cash loss are buffered or absorbed by the tax system. Because of the tax effects your loss is reduced. Simply put: the tax man and the rental income pays for your investment property!!

The term ‘negative gearing’, while used extensively in Australia, is ambiguous. A bank would not grant a loan of greater amount than the value of the asset being acquired (plus other security) so it’s unclear in what respect gearing itself could ever be negative. The only item which is negative in negative gearing is net income, and this could conceivably be negative without borrowing. Nevertheless, negative gearing, for decades, has made it easier for investors to accumulate properties and let them grow in value over time.

Negative gearing has been around for a long time – since the 1930s in fact (when the Income Tax Assessment Act was passed by the Commonwealth parliament). The act does not mention the phrase ‘Negative Gearing’ at all, but what it does is ensconce the principle – across all types of business and income earning activity – that income is taxable, and the expenses earned in assessing that income are deductible from that income. And that, as it applies to property investment, is what allows negative gearing to occur.

Positive Gearing

Positive Gearing occurs when you borrow to invest in an income producing asset and the returns (income) from that asset exceed the cost of borrowing.

Deduction checklist for investment properties

Below is a checklist of typical deductions directly related to rental properties that can be claimed:

  • Body Corporate Fees
  • Borrowing Expenses (For example, stamp duty and legal fees on mortgage)
  • Building depreciation (depending on date of construction)
  • Cleaning Costs
  • Council Rates
  • Depreciation of fixtures and fittings (light fittings, carpets etc)
  • Insurance Costs
  • Interest on loans (including interest prepaid up to 12 months in advance) and related bank charges
  • Land Tax
  • Pest Control Costs
  • Property Agent Management Fees
  • Repairs and Maintenance (excluding improvements which are treated
    as capital and added to the cost base of the asset for capital gains tax purposes rather than being claimed as an immediate deduction)
  • Telephone, postage and stationary
  • Travelling Expenses
  • Water Rates

The calculation of depreciable items is very specialised and should always be carried out by a qualified professional. Investors should always use an accountant who specialises in property investment to ensure all tax deductions are claimed. Further, ARPP recommends investors use the services of a Quantity Surveyor to ensure maximum deductions of their depreciable items.

When selecting your investment property, there are many factors to consider, one of them is new or existing. There is a major advantage with new property. That is, it allows you to maximise your tax advantages and to reduce the out of pocket costs to yourself to fund the property (see info pack for more details).

Can Negative Gearing Help Fund Your Retirement?

If negative gearing can produce high investment returns in a tax effective way, it stands to reason that it can serve as a very powerful instrument in building assets for retirement.

Negative gearing has traditionally been a lucrative way to build returns through high capital growth. Negative Gearing can be a viable tool in the accumulation phase provided the cash flow is there to sustain it. However it is important to note that the success of negative gearing depends on the quality of the underlying assets. In other words careful selection and accumulation of your investment properties is paramount, both in terms of the underlying return and the potential capital growth.

Negative Gearing – Key Points

  • Invest in areas of good capital growth potential – An investment properties capital growth will more than make up for its short term cash loss, or future profits will be greater than present losses;
  • You are willing to accept wealth in the form of non-spendable capital gains (or future profits) in a short or medium term.
  • Non-taxed (or delayed tax) capital growth is a far more effective wealth-accumulation mechanism than income which is realised and taxed.

Negative Gearing is often sold as a tax minimisation tool, but really it should be considered an investment enhancement tool.

Further information on negative gearing, positive and neutral gearing, including a look at the nuts and bolts of negative gearing through an example is available in the free information pack.

Contact us for a free personalised assessment to see how negative gearing could work for you now and in the future.

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