While most investors are familiar with the concept of property investing in general, there are some topics such as positive gearing that require more research to fully understand the ins and outs.
Positive gearing is where you borrow money to invest, and the income from your investment is greater than your interest and other expenses.
Chan & Naylor founder Ed Chan, in a video interview with YourMortgage.com.au, confirms that a positive cash flow investment is one where the rent more than covers your expenses.
For instance, if a property costs you $500 per week to own in terms of interest repayments, council rates and management fees, and you rent is $575 per week, then your property generates a positive cashflow worth $75 per week.
However, he adds that while property investors will therefore have extra money in their budget, they will also have to pay tax on the additional net income.
“You have to pay tax on that rental income; it is extra money in your bank, but then you’ll pay tax. The tax rate that you pay is based on your personal tax rate, so if you’re on a 20% tax rate, then you’ll pay 20% tax on your additional rental income. If you’re on a 47% tax rate, you’ll pay 47%,” he says.
Chan adds that while many investors strive to find a property that is positively-geared, in real estate, the bigger cities are mostly full of negatively-geared investment options. These are properties where the rents will not be able to cover the outgoings, so investors have to dip into their own savings and income to fund the shortfall.
“Interest rates have been coming down, and as the further it comes down, the closer you are towards being neutrally-geared or positively-geared as an investor,” Chan shares.
Chan further warns that a lot of positively-geared properties do not show the same capital growth as negatively-geared properties.
“The reason why particular properties are negatively-geared is because the capital growth potential is quite high as a proportion of your income. The reason why it is quite high is because the demand for the property pushes the value of the property up,” he says.
Claiming expenses for property investment
There are expenses incurred when renting out an investment property, which are going to be taken out of the rental income. For these expenses, investors can generally claim a tax deduction, which will help offset the costs of owning the investment property.
“Most of the costs and expenses [that have something] to do with the property itself [can be claimed], whether it’s water rates, council rates, or mortgage interest repayments. Repairs and maintenance, too, although there’s a difference between repairs and capital works. Meaning, if you repair something and put it back to its original position, then it’s a repair and you can claim that completely. But if you a whole renovation or replacement at once and you’re improving the item – if you put in a new kitchen, for example – then you can only depreciate that, you can't claim it,” Chan says.
For instance, if you have a broken cupboard in your kitchen, and you replace it, that would be a repair, provided that you repaired it to its original position. However, as soon as you improve the cupboard by installing a new type of cupboard, or replacing all of the cupboards instead of the one broken one, that would be considered an improvement.
Claiming for expenses begins with getting a receipt from the supplier and then taking that receipt and using that as evidence of having incurred the cost.
There are many ways to deploy this strategy effectively, depending on your personal situation, finances and income. For instance, some believe that if you are going to have a positively geared property, then you may want to balance it with a negative one, so that you are going to have capital growth from one and cash flow from the other – so they balance each other out.
Leveraging a positive cash flow investment for your financial benefit should involve thorough planning, and/or a consultation with an professional property advisor, accountant and/or financial planner.
To find out what type of gearing is best for you, read this: Which type for gearing is best for you