What Is Negative Gearing?
Negative Gearing by definition is where you borrow to acquire an investment or asset and the interest and other tax deductible costs you incur exceed the income you receive from the investment.
While Negative Gearing is commonly associated with rental properties, it can also be applied to other types of income-producing investments such as shares and managed funds. In terms of property investment, negative gearing refers to the scenario where your expenses to maintain the property (including mortgage interest) exceed the rental income.
Creating wealth through purchasing an investment property is a well established practice in this country. The attraction of borrowing or gearing to invest is that it enables you to invest in shares or property that might otherwise have been unaffordable. For individuals, the loss can also be offset against other assessable income and the tax benefit will depend on your marginal tax rate.
Make no mistake, 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:
- Properties are expected to generate profits only through capital gains and the gains need to be greater than the total losses incurred over the course of the holding period. Of course, there is no guarantee that the value of the property will appreciate, or at least appreciate enough to cover your losses.
- Investing in property requires planning and extra caution must be exercised when a property is projected to generate a negative cash flow. Tax benefits should not be the only reason for the property purchase.
- For taxation purposes, depreciation on the building could be tax deductible, however, the depreciation also reduces the ‘cost base’ of the property. The greater the depreciation you apply on your property, the lower the cost base value which may result in a larger taxable capital gain on sale.
- Negative Gearing isn't suitable for all investors. Although it can lower your tax liability, the tax implications will depend on your personal situation and the type of investment you choose. Negative Gearing implies a negative cashflow that you need to fund from other sources.
- You have to remember that the family home is a purchase from the heart while an investment property needs to be a purchase from the head.
Stay tuned for a worked example on negative gearing.
How We Can Help You
The real benefits of negative gearing are only realized 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:
- We have written a comprehensive booklet on Negative Gearing that explores what you can claim, what costs form part of the cost base for capital gains tax purposes and how negative gearing works for tax purposes. It is available to our clients in conjunction with a negative gearing consultation.
- Evaluate the tax consequences – Using an intelligent software tool we can prepare a 10 year cash flow analysis of the proposed property, taxable income forecasts and equity projections.
- Where to buy – through the services of a buyer’s advocate we are able to help you locate the right property in the right location.
- Finance – through our affiliation with a mortgage broking group we can help you find the right loan that is correctly structured for maximum tax effect.
- The tax loss on the property can pose a major cashflow issue, however, we can prepare a PAYG variation application so that your regular pay packet reflects the annual tax saving.
If you are interested in finding out more about negative gearing and property contact us today.