What is Negative Gearing?

Negative gearing occurs when you borrow money to make an investment, and the ongoing expenses of that investment are greater than the ongoing income you receive from it. In this scenario, you may be able to deduct this ongoing loss from your total taxable income for the financial year, saving you on tax. This can be applied to any asset, be that property or shares. 

There isn’t a set process defining how to negative gear, nor will you find it in legislation. The ATO states “your rental property is said to be ‘negatively geared’ if your deductible expenses are more than the income you earn from the property.”

For that financial year, the ATO then deems the tax result of your property as a net rental loss. You then may be able to claim a deduction for that loss, bringing down your total taxable income for the year and saving you money on tax. If your income isn’t large enough to absorb the rental loss, you can carry it forward to the following financial year’s income.

What can you claim on negative gearing?

Deductions you can claim typically fall into things you the investor have paid for, not the tenant. These could include:

  • The interest on your mortgage
  • Advertising if you need to find new tenants
  • Bank fees and loan fees
  • Body corporate fees
  • Depreciation
  • Council fees
  • Cleaning costs
  • Legal expenses
  • Land tax
  • Property management fees
  • Insurance costs
  • Electricity, water, and gas not paid for by the tenant
  • Repairs and maintenance

Key Benefits of negative gearing

  1. Reduces tax liability

Property investors in Australia currently benefit from a reduced tax liability from the federal government.

This is because they are helping to boost the number of available rental properties as well as keeping weekly rental amounts competitive.

Changes to the negative gearing laws can impact how attractive property is as an asset class, which is why the topic attracts so much attention at each election.

Other benefits from Negative Gearing 

  1. Ability to build an investment portfolio

Investors are able to take advantage of negative gearing to hold on to investments that have a growth potential.

The cost of holding the property is shared between the investors, tenant and the tax man.

Meaning that if the annual property cost is $35,000, and the tenant pays $25,000 in rent, the tax man pays $4,000, the investor only needs to pay for $6000 of out of pocket expenses. Which the ATO is providing a tax break helping the investor to amortise the cost of keeping the property. 

Many high income earners like this strategy because they are redirecting the tax bill into an investment property that will likely appreciate in the future.

  1. The market value will increase over time

Capital growth is where an asset increases in value over time. For example, if a property is purchased for $700,000 and then sold five years later for $850,000 this $150,000 difference in value is referred to as capital growth.

Historically, property in Australia generally increases in value over the long term. Even with drops in prices from time to time the general trend is that values have increased.

  1. Regular weekly income

Depending on their situation, many investors have a regular income from the rent paid by tenants that covers some of their ongoing costs.

Investors may use this income in various ways, which can include building up equity to purchase more assets or simply paying down the principal amount so that the mortgage is paid off quicker.

Negative gearing case study

The case study below is taken from this article on Why Doctors Should Consider Real Estate Investing.

Rental Property for Negative Gearing

John, is an anaesthetist working on a public job and also with private practice income. He earns $300,000 from his public job and $400,000 from his private practice. He will pay up to 47% in taxes, because he earns more than $180,000 per year. 

John decides to buy an investment property to minimise his tax bill. He buys an investment property in Brisbane for $600,000. He then made a $60,000 deposit (10% of the property’s value).

His monthly repayments are as follows:

Rental Income  $28,000.00 
Interest expenses (5.6% interest rate) $30,240.00 
 
Agent Commission 7% $1,960.00
Advertising  $396.00
Council Rates $1,200.00 
Insurance  $310.00
Other expenses  $1,900.00 
Total Expenses: $36,006.00 

John’s total investment expenses for the year came to $36,006.00. He paid $8,006.00 more in expenses than what he earned in rental income.

By including a property depreciation amounting to $8,500.00, his property is negatively geared and he can use the $16,506.00 loss to reduce his taxable income – and by extension – reduce his tax bill. 

Net cash Flow -$8,006.00 
Property Depreciation -$8,500.00 
Total Negative Geared -$16,506.00 
Tax rebate (47%) (-$16,506 x 47%) $7,757.82 
Net cost to maintain investment (-$8,006 + $7,757.82) -$248.18 

Risks associated with investment property negative gearing

Negative gearing can be a risky business because while gearing can amplify your gains, it can also magnify your losses. If you negatively gear property, you need to understand some important points:

When you negatively gear your property, you still record a loss. And a loss is a loss. Before you commit to negatively gearing your investment property (or multiple investment properties) it is worth considering what the repercussions of doing so are.

Ask yourself:

What happens if you have difficulty filling your rental property at any one time?

What if there is a dramatic turn down in property values and your investment fails to increase in value?

What if interest rates rise very quickly and you have just agreed with your tenants that you will not raise rents for at least 12 months?

These are not questions that should be answered quickly or treated lightly. Take the time to do your due diligence and know how you would cope if any of the above scenarios came true. If you are confident that you could easily handle any losses in income etc, then you are on the right track.

Of course, if you do choose to negatively gear your investment, there are some easy ways for you to minimise the risks associated with doing so.

Minimising the risks of negative gearing

1. Choose your investment property wisely

Buying a property that is located near all the major amenities and appeals to a wide range of tenants should help you to ensure your investment property is never vacant for very long.

2. Manage your income

When managing an investment property, there are times when it will cost you a significant amount of money – when the property is vacant, when it needs repairs etc. So, before deciding on negative gearing make sure you have enough income to successfully manage all the expenses that come with owning a property – not just day to day expenses, but all expenses.

3. Protect yourself and your investment

As a property investor, it is critical that you adequately protect and insure not only your property, but yourself in the event that unforeseen circumstances arise. It never hurts to be prepared for the worst case scenario. You can speak to your mortgage broker or financial adviser to learn more about the types of insurances you should have as a property investor.

How We Can Help You

The real benefits of negative gearing are only realised when you combine the correct tax and financial advice with the right property and loan product. You should always seek expert advice to make sure the purchase is within your budget and will provide taxation and financial benefits in the long run.When buying an investment property we can assist you in several areas. BloomWealth will help you through the whole process, identify the risks associated with negative gearing and help you formulate a plan to not only minimise the risks, but tackle any hurdles that you may face during your investment journey. Speak to one our BloomWealth Accountants now.

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