Terms such as depreciation, capital gains, and, of course, negative gearing can sound confusing – particularly to those unfamiliar with property investing. But negative gearing is a pretty simple concept to understand once we strip out the financial jargon.
So, what is negative gearing and how does it work? Here are the answers to many of the most common negative-gearing questions.
Simple explanation: What is negative gearing?
The definition of negative gearing can be broken down into its two components 'negative' and 'gearing'.
Gearing means to borrow money and use it to invest. You can use gearing to invest in property, shares, or another vehicle entirely, but this article will focus on property investing.
Now we come to positive and negative gearing.
A positively geared investor is one who is making more from their investments than they are spending to hold them.
A negatively geared investor, on the other hand, is one who is losing money on their investment. Ergo, their interest expenses, maintenance costs, and other outgoings tally up to more than the rental income they're bringing in.
How does negative gearing work?
That's pretty easy, right? Well, where it gets more complicated is when considering the tax offset that goes by the same name.
A negatively geared investor can deduct the total losses they realise from an investment property from their pre-tax income – including their rental income and wages. By doing so, they may pay less income tax, even on income unrelated to their investment.
Let's use an example:
Damien has an investment property in Newcastle. It brings in $550 a week in rent – equaling $28,600 a year.
To buy his property, he took out a $600,000 home loan with a 6% p.a. interest rate and makes interest only repayments of around $690 per week.
Without considering other costs, like property management fees, insurance, and maintenance, he spends nearly $35,900 to hold his investment. That means he is at least $7,300 in the red each year on that investment.
However, he also earns $100,000 at his corporate management job. Thus, he would pay nearly $23,000 in income tax in the financial year 2023-24. That is, unless he negatively gears.
He can subtract the $7,300 of losses he realised from his investment property from his $100,000 income, leaving him with just $92,700 of taxable income, on which he would pay nearly $20,600 of tax – $2,400 less than he might have otherwise.
See also: Income Tax Calculator
If you're considering negative gearing, or you're currently losing money on an investment property and want to see where you might stand at tax time, you might find Your Mortgage's Negative Gearing Calculator useful.
Does a negative geared property make a good investment?
Of course, Damien is still in the red, even after he reduces his taxable income by the amount he lost on his investment property. He has ultimately minimised his losses, he didn't wipe them out entirely.
By definition, a negatively geared asset is a cash flow drain – you're losing money in the short term. But investors like Damien might still hold onto such properties if they expect the property's value to grow over time.
It's also worth noting that the higher your income, the more you can potentially save through negative gearing. Australia's tiered tax system means high-income earners generally pay a higher rate of tax – and therefore, they receive a larger tax benefit from deducting investment losses.
Finally, it's not uncommon for a property investment to start out being negatively geared. Then, as rents rise (typically due to inflation) and mortgage costs fall (often due to the principal balance being repaid), the tables may turn and a once-loss-making investment can eventually become positively geared.
Top home loans available for property investors right now
Whether you hope to be positively geared or negatively geared, a competitive home loan can make a big difference to an investment's performance and profitability. Here are some of the lowest-rate investor home loans available right now:
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Is it better to be positively geared or negatively geared?
Assumably, most investors who purchase property hope to one day be positively geared.
As mentioned above, a negatively geared property might save a person from paying some income tax, but the tax deduction can only ever negate losses, it can't eliminate them.
The highest income tax rate a person can typically pay in Australia is 45% – or 45 cents of income tax for each $1 earned.
For that reason, a $10,000 loss can generally offset a maximum of $4,500 of income tax – leaving a $5,500 gap.
On the other hand, it's common for a property investor to be negatively geared for a period of time after they purchase a property. Many assume inflation will increase their rental income in the years following their purchase. Meanwhile, the size of their home loan will likely remain the same or shrink, depending on whether they're making interest only repayments or principal and interest repayments.
Thus, negative gearing is a strategy used by many on their journey to owning a positively geared property.
Why is negative gearing so controversial?
There's no denying negative gearing is controversial.
Critics argue the tax discount makes the property market less fair. Many believe that, since negative gearing is more effective for those on higher incomes, it leads them to spend more on property than they otherwise would. Therefore, investors are arguably driving up property values, pricing less wealthy Australians seeking to buy a home out of the market.
Negative gearing has been a political football for decades. In fact, it was briefly near-abolished in the 1980s.
In more recent times, the Australian Labor Party lost two elections – in 2016 and 2019 – on the promise of negative gearing reforms.
Risks of having a negatively geared property
Owning a negatively geared property brings numerous risks, most relating to cash flow.
To be negatively geared means to be losing money, no matter how glittery the term might sound.
If a property investor were to be already losing money week-in, week-out, what might happen if they find their property empty for an extended period of time or if they're faced with costly repairs?
The other risk that runs with negative gearing is its inherently political nature.
While the electorate currently appears to favour negative gearing, the pendulum could swing in the future – potentially disrupting investors' strategies.
And that's all before considering the risks associated with investing in property to begin with.
Image by Towfiqu barbhuiya on Unsplash
Collections: Negative Gearing Property Investment
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