Negative Gearing Explained…
Negative gearing is a catchphrase you’ll see over and again when reading investment magazines or interacting on property forums. Although it sounds complex, in principle negative gearing is a simple concept: it is tax-effective property investment. Embraced with enthusiasm by Australian investors nationally, negative gearing promotes property investment, increases the amount of private rental properties available to the wider community, and assists individuals minimize their annual tax bill while building a valuable portfolio of assets. It’s a win-win proposition! IPRG explains the finer details of how negative gearing makes property investment.
Get Into Gear
First things first – let’s look at ‘gearing’. Be it positive, negative or neutral, gearing means borrowing money to buy an asset such as property. Positive gearing means that the interest you are paying on the loan is less than the income, and that you are making a profit. Neutral gearing means that the interest you are paying on a loan is equal to the income, and that you’re breaking even. Negative gearing means that the interest you are paying on the loan is more than the income, and that you are making a loss. Normally, we all want to avoid making a loss – but in the case of property investment, making a loss is a positive position to be in. Why? Because you’ll receive a multiple benefits: reducing your tax bill while enjoying ownership of an asset which is increasing in value.
Let’s look at a simple example – you purchase a home for $500,000. Your tenants are paying a healthy sum to rent to property from you, but it doesn’t quite cover the interest repayments (this is entirely normal and indeed a desirable outcome). This is a negatively geared investment, and you’ll need to put some of your own funds towards making your loan repayment each month. To help you bear the cost of this investment, the government offers you a tax break on the interest component of the loan you have taken out to purchase the property – helping you hold the property for longer, affordable, sustainable and practical for savvy Australians. providing housing to tenants and giving you the opportunity to build a property portfolio for your future financial security.
Position means everything when it comes to purchasing an investment that fits the negatively geared, tax-effective property investment model to benefit you most. Look for properties that offer you that perfect balance of capital growth with an affordable level of negative gearing. In general, you’ll find these ideal investment properties in areas which are just beyond a ‘booming’ suburb, well-serviced by public transport, offering access to amenities including schools, shopping, park lands and health services. Before you know it, those seeking to purchase in the ‘booming’ suburb will flood into your own neighbourhood – increasing property values as a natural flow-on effect. This is the negative gearing sweet-spot, maximising potential for your investment property’s capital gain while still giving you the chance to minimise your taxation obligations.
Seeking to purchase further afield? Buy investment property in regional or rural areas with caution – although these properties are more likely to offer positive or neutral cashflow, they will not offer desirable tax benefits and indeed may result in you having to pay additional income tax. Regional and rural property is also less likely to offer you strong capital growth, defeating the purpose of property investment overall. Of course, there are exceptions to these rules – but they are few and far between.
Better Together: Negative Gearing and Depreciation Schedules
Tax-effective property purchase is enabled by negative gearing and further enhanced by a depreciation schedule. A depreciation schedule increases the deductions (or losses) you may claim against your investment property. Prepared by a specialist quantity surveyor, a depreciation schedule works in tandem with negative gearing, making sure you maximise the cash return from your investment property. It itemises costs associated with the construction of the property itself, and the ‘plant’ (better known as fixtures and fittings!) within the property – providing a schedule of deductions to claim as your property ages. New properties are ideal for maximising such claims, as they are rich with new items, quickly ‘depreciating’. The amount you may expect to depreciate depends on the age of the building, its use and fit out. Consult with a knowledgeable adviser when selecting your tax-effective property, as not all properties offer the same depreciation benefits.
Purchasing a tax-effective investment property helps you generate a good tax return by reducing your taxable income. Each year, billions of dollars in personal tax revenue is minimized through tax-effective investment property strategy. This reduction in personal tax debt is the primary reason why many Australians are drawn to this category of investment – that, and our collective love affair with property ownership!
At some point in time, your property may change from being negatively geared to neutrally or positively geared. What you do at this point is up to you: some investors choose to sell at this stage, preferring to own investments that offer tax benefits and are negatively geared. If you do sell and make a capital gain on your investment (i.e. the property value exceeds the accumulated losses accrued) a potentially taxable profit has been made – so consult closely with a trusted adviser such as an accountant or financial adviser to plan managing this part of the negative gearing property investment cycle.
Losing for Winners
You’ve worked hard to progress your career, and now you’re in a position to plan for the future. Congratulations! You may have a young family, you may have just reached a new wage bracket, you may be considering retirement or perhaps you’re planning an exit from a small business. Purchasing tax-effective property is ideal in any of these situations – as the higher your income and the larger your tax return, the more tax you are required to pay. For individuals earning over $80,000 per annum, negative gearing is an excellent tax incentive designed specifically to help you buy investment property. You are rewarded by the tax department for taking on investment debt, as you are helping to provide ready rental accommodation for our society. The tax breaks are yours for the taking, so embrace them by judiciously choosing a tax-effective investment property that ‘ticks all the boxes’.