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  • Negative gearing and its positive results

    Many people turn to property as an alternative to other forms of investment, especially when they seek capital growth, tax benefits and future retirement income. 

    A large number of investment properties purchased to create rental income, can be financed and serviced (in part) through a method called negative gearing.

    What is negative gearing?

    A negatively geared investment is where the interest on the amount borrowed exceeds the net income received from the investment’s rental income. 

    The Australian Tax Office (ATO) currently allows investors to claim a tax deduction on the difference between the interest paid and the net income from the property in certain circumstances. 

    When buying an investment property in this or any other way, you need to realise the full tax implications, so you can make the right choices for your circumstances. 

    While negative gearing can provide tax benefits for many people, you should consult a professional tax adviser or accountant to help you decide whether it’s the right investment strategy for you.

    The benefits of negative gearing

    When your investment property is negatively geared, you may be entitled to deductions based on: 

    • The interest paid on the loan
    • The costs of setting up the loan, including establishment fees
    • Letting agent fees to manage the property
    • The cost of advertising for tenants
    • Council rates and land tax
    • Owners’ corporation levies
    • Insurance premiums
    • Depreciation of fixtures and fittings, including furniture
    • Repairs and maintenance 

    The key benefit of negative gearing is that it may enable you to offset costs associated with your loan and renting out the property against your taxable income — and at the highest rate of tax that you pay.

    The interest-only loan

    The interest payment tax deduction makes interest-only loans especially attractive to investors paying the highest tax rate. 

    For example, you have a property rented for $1,000 a month, giving you an annual rental income of $12,000. If your loan interest payments and allowable expenses amount to $18,000 for the year, you have made a loss of $6,000 on the property. 

    This loss could be offset against your personal income. 

    At the same time, it’s important to make sure you have the financial reserves to meet the repayment shortfall and ongoing costs. 

    For this reason, negative gearing best suits investors with reliable cash flow and surplus income.

    Increasing value of the property

    In addition to any potential tax benefits, a rental property may increase in value over time. Say it was purchased for $400,000 and you paid a deposit of $40,000 with a loan of $360,000. 

    If the property increased in value by 10%, that would mean a gain in equity of $40,000. This would mean a 100% return on your own original funds   of $40,000. 

    But remember: when you decide to sell the property, you will be subject to capital gains tax on any increase in its value. And increases in property values take time, so property investment should always be considered to be a long term strategy.

    Making negative gearing work for you

    To succeed in property investment through negative gearing, you need to have a clear understanding of everything involved. 

    You need to be aware of all the deductions available to you and to remember the need to provide for capital gains when you sell. 

    Your personal circumstances will determine how well negative gearing may work, which is why you should seek professional tax advice.

    Negative gearing does not suit all investors

    You should consult your financial adviser about whether negative gearing is right for your financial situation. Of course, it’s not a good idea to invest purely for tax reasons. Ultimately, most investors want their investment to either: 

    • Turn profitable at some point in the future, that is, become ‘positively geared’, or
    • Grow in value so that they can sell it for a capital gain that compensates for any income lost along the way. (However, note that capital gains tax will most likely be payable if the investment is sold). 

    Cash flow is key

    In the meantime, you need to have the financial reserves to meet repayment shortfalls and ongoing costs. 

    For this reason, you shouldn’t start a negative gearing strategy unless you have a reliable income that generates enough surplus cash each month to meet the additional financial commitment of owning and maintaining an investment property.  

    Borrowing to invest: What to consider

    Factors you should consider before deciding to borrow to invest include:   

    • Think about the investment first, not the tax benefit. Even if you decide to negatively gear, sooner or later you will want your investment to turn a profit
    • Look for an investment property that will give you a reliable and rising income
    • Have realistic expectations for your investment returns – research similar properties in the area
    • Set a realistic timeframe in which to achieve your target – residential property investment should be viewed as a long term investment strategy
    • Do not borrow to your maximum capacity, or more than you can comfortably afford
    • Make sure you can meet higher repayments if interest rates rise – the last thing you want is to be forced to sell in a hurry
    • Be aware that investments can lose value due to circumstances beyond your control, such as economic, environmental or legislative changes. 

    Like to know more?

    Before deciding to invest in property you should consult a professional tax adviser or accountant to help you decide whether this strategy is right for you. 

    Why not contact a RAMS Home Loan Expert for more information on borrowing to purchase an investment property.