It is bound that somewhere in our everyday conversations, either whilst waiting for our bus in the morning or waiting for our coffee we have heard the term “negative gearing.” But let’s analyse what all the debate is actually about….
What is Negative Gearing?
- Gearing simply means borrowing money to further invest.
- Negative gearing is the practice of investing borrowed money where the result of the investment is a loss which is tax beneficial.
Is Negative Gearing Common?
Those who own investment properties, negative gearing is very common and a hotly disputed subject. Negative gearing isn’t limited towards properties, it applies in any situation where funds have been borrowed for investment purposes.
Considering investment properties, negative gearing occurs when the rental income generated by the rental property isn’t enough to cover the expenditures incurred by the property. These expenses include, interest expenses, repairs and maintenance, depreciation and many more.
Is Negative Gearing Worth it?
My clients always ask me, is negative gearing good or bad? I follow this question up with technical jargon that nobody really understands.
A negatively geared rental property simply is running on a loss. That property costs more to maintain than the income it is producing (ignoring the gain/loss on the value of the property). However, that loss reduces your taxable income, which then leads to a direct tax saving. So, is it worth it? The following analysis, should shed some light on this question. We have prepared two tables, which highlights the tax effects of negatively geared properties and positively geared properties on individuals in various tax brackets.
- Rental Property is owned by an individual
- Ignore effects of tax offsets, levy’s and prepaid tax.
- Ignore effect of increase or decrease in value of a property.
- All scenarios have the same work related deductions.
So, Is It Good or Bad?
In all four scenarios, when making a rental loss, individuals end up losing money. The loss on a rental property tends to exceed the benefit of the tax saving. As you can see, the gap between the rental loss and the tax saved narrows at higher tax brackets.
If you are intending to buy a property for the sake of negative gearing,I would advice you to revise your strategy. It is not tax effective. We would rather you pay more tax and keep your hard earned income in your pocket.
However, if you have bought a property and it is naturally negatively geared, then take use of the tax benefit and hope the capital value of the home rises high enough to overcome the loss on the day to day running of a rental property.
Is this the strategy for you?
Whether this option is successful for you depends on a number of factors.
Firstly, this strategy requires you to be well informed and conduct a lot of research before employing it into your investment situation. As a common rule, negative gearing is best moulded for those investors who have the financial capacity to support themselves from decreased cash flows arising from the investment.
Not only do you have to stand up to the shortcomings in cash flow from negatively geared properties, you need to safeguard yourself from other economic conditions such as interest rate fluctuations. Another scenario that could arise includes the property being untenanted for some periods of time. Therefore as a general rule again, you require a reliable income to shield yourself from circumstances changing.
To my clients, and any readers, who ask should I buy a property to reduce my tax? The answer is NO. We want you to buy a property , make rental gains and eventual capital gains. Tax is just a relentless, undying and unforgiving consequence.
However should you require more personal advice and guidance, please do not hesitate to contact us. We understand that negative gearing can be complex and therefore allow us to provide you with the best support we can so you make sound investment decisions.