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Negative Gearing Explained

Negative gearing is a popular investment strategy that can assist you to reduce your investment property holding costs. In this edition of Property Insight, we explore the concept of negative gearing and explain how this strategy can be used effectively to meet your financial goals.

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So what is gearing?

The term ‘gearing’ basically relates to how you manage the expenses and income of an investment. Gearing applies not only to property, but also to stocks and shares. When it comes to property, gearing is commonly thought of in terms of negative and positive. Positive gearing is where you borrow to invest and the property generates a positive income stream. Negative gearing is where you borrow to invest and the property generates a negative income stream or a loss, which can then be claimed as a tax offset. Your property investment can also be neutrally geared, with the income and expenses breaking even.

 Check out our case study on negative gearing

How is losing money considered a wise investment strategy?

Buying an investment property is an important financial decision that is part of an overall strategy designed to meet both your shortand long-term goals. This strategy should be based on your current financial position and personal circumstances.

With this in mind, the main reason investors use negative gearing as a strategy is to reduce taxable income, while building wealth through potential capital growth. Put simply, if you make a loss on an investment property, you can claim a tax reduction on your income (known as a tax offset). You can then use the tax offset to lower your tax bracket, meaning you pay less tax.

Negative gearing is a particularly popular strategy with high-income earners who are looking for ways to build wealth and have the tax department help fund the investment. So is your property working for you in the long-term if you do not have positive cash flow? Yes! With a well-chosen investment property, rental returns should increase over a period of time, changing the property from negatively geared to neutrally geared, and finally to positively geared. This means you should be able to recover any losses through rental increases and reduced tax payments.

Furthermore, when you sell a property, the capital growth should cover any losses and, if executed correctly, put cash in your pocket!

Why would I choose a negatively geared property?

Generally speaking, positively geared properties are not located in the most highly desirable locations or close to core infrastructure, therefore they don’t achieve the same strong rate of capital growth. Additionally, a positively geared property may not reduce your taxable income. In fact, you may be required to pay additional tax on any income derived from a positively geared investment.

This is where your financial goals are integral to the type of property you purchase. For example, if you have a short-term goal of reducing your taxable income, with a long-term goal of selling for maximum capital growth, a negatively geared property can allow you to achieve this.

Why do we have negative gearing in Australia?

Without such stimulus in the real estate market, the government would be required to supply more affordable housing. To put things into context, population projections by the National Housing Supply Council show that over the twenty years to 2030, the gap between housing supply and demand will grow to 640,200 dwellings in Australia.

The tax benefits available for negative gearing are intended to help people buy investment properties by minimising potential short-term cash flow issues. In other words, negative gearing makes the property market more accessible to everyday investors.

The pitfalls

As with any investment scenario, there are drawbacks to negative gearing. It is a long-term property strategy that should only be adopted if you can sustain a shortfall, and with this in mind you should consider how you would cope in a range of worst-case scenarios. All types of investments experience cycles triggered by factors such as rising and falling interest rates and property values, changing government policies, population demographics and unforeseen events.

Specific property-investment risks can include short- and long-term tenant vacancies or unreliable tenants, resulting in the loss of income from rent. These risks can be minimised by following the market and choosing a property in a highly desirable rental location with strong prospects for capital growth.

There are, of course, other ways to reduce the risks – with many investors balancing their property portfolio with negative and positively geared properties. Depending on your goals, you may choose a combination of both, with negatively geared properties positioned for stronger capital growth, and positively geared properties that offset any losses. It all comes down to what you hope to achieve in the short- and long-term.

Claiming further tax offsets (depreciation and deductions)

On top of the tax offsets we have already discussed for negatively geared properties, you can also claim depreciation and deductions, further reducing your costs. Depreciation and deductions are also available to positively geared properties. There are essentially two depreciation types: ‘building’ and ‘fixture and fittings’. Building depreciation is where the value of the building is reduced yearly for up to 40 years. This is different to fixture and fitting depreciation where a deduction is taken over the life of a fixture or fitting. You can also claim any purchasing costs that were incurred to set up the property, such as lenders mortgage insurance (LMI), over the first five years, and also ongoing costs such as bank-loan interest.

This is a specialised area of tax and to claim your depreciation costs the Australian Tax Office requires a depreciation schedule by a registered Quantity Surveyor. It is also beneficial to engage a tax agent who specialises in property tax to get the most out of your tax benefits.

A long-term strategy

At the end of the day, your long-term goals should dictate the investment strategy that best suits your circumstances. A good strategy will help you choose an investment that creates the balance between returns and security that suits you. Negative gearing is a long-term strategy that, if successfully executed, should pay excellent dividends through capital growth.

Check out our case study on negative gearing


DISCLAIMER: Whilst the publisher and author believe that the information contained in the publication is based on reliable and researched information, no warranty is given as to its accuracy and persons relying on this information do so at their own risk. Anyone who intends to use the information as the basis for making financial or business decisions should first obtain advice from a qualified professional person. This article is published on the understanding that neither the publisher nor the author - is responsible for the results of any action taken on the basis of the information published; and is not engaged in rendering legal, accounting, professional or other advice or services. The publisher and author expressly disclaim all liability and responsibility to any reader of this publication as a consequence of anything done, or not done, by a reader relying upon any part of this publication. (C) This article may not be reproduced in full or in part without the specific written consent of Which Property? and the Author.

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