Property investment: understanding negative gearing
If you're interested in property, you've probably heard of negative gearing. But if you want to know more about what it is and how it works, you’ve come to the right place. For investors, negative gearing has significant implications and understanding it could help you save on tax, and it could also help you better manage your investment properties and cash flow.
What's negative gearing and how does it work?
At a basic level, the term gearing means money you borrow to invest. Whether you're positively, negatively, or neutrally geared depends on the rental income and your outgoings, including interest and other associated expenses.
- Positive gearing - Your property is positively geared if the income from your investment is more than your interest payments and outgoings like maintenance and repair costs.
- Negatively gearing - Your property is negatively geared if the income from your investment is less than your interest payments and outgoings.
- Neutral gearing - Your property could be neutrally geared, which means the income is equal to your interest payments and outgoings.
You can claim a deduction for things like body corporate fees, advertising for tenants, insurance, land tax, gardening and cleaning fees, and council and water rates. Check the ATO's rental property guide for a list of things you can claim, and always consult with your tax advisor for more information.
Implications of negative gearing for property investors
Negative gearing has been a popular strategy with Australian property investors for years, and collectively it helps people save billions in tax each year. If your property is negatively geared, then obviously you'll need to cover the shortfall out of pocket. However, the biggest implication comes down to how negative gearing could reduce your taxable income.
Under Australia's tax law, you might be able to claim the interest and some outgoings as expenses. For example, you could claim the interest part of your loan repayments, along with repairs and maintenance costs on the property as expenses. Your net loss on the property could then be offset against your personal income, which means your taxable income would be reduced. By the same token, investors with a positively geared property will need to pay tax on their rental income profit.
Negative gearing and your investment strategy
While negative gearing offers financial benefits, it's important to keep in mind tax savings only play a role in the bigger picture of a viable investment property. So while negative gearing could help you save on tax, this shouldn't be the only reason you're investing in a particular property or the sole driver of your strategy. For example, if you're in a higher income tax bracket and you own an investment property with high capital growth potential, negative gearing could complement your long-term goals. The appeal of negative gearing to some investors underlines the fact investors don't always expect to make money from the rent alone, but on capital growth over time.
Negative gearing can be a bonus advantage of property investing if you focus on building equity in your property by accelerating repayments to pay down your loan. Where your total return - capital growth plus rental yield - is larger than the total cost of buying and owning your property, then negative gearing could be very beneficial.
Note: you could be negatively geared but cash-flow positive. This is possible if you have sufficient capital works allowances and fixtures and fittings in the property that can be depreciated.
Bottom line: is negative gearing a good strategy?
Yes, negative gearing could be a good complementary strategy to your overall property investment plans if you get it right. You need to ensure you fully understand how it works, including the deductions you can claim. Additionally, it works best when you find a property with good capital growth prospects. Negative gearing isn't without its risks, so make sure you have the financial foundation to cushion a fall in the value of your property, a rise in interest rates, and/or long vacancy periods.
Negative gearing is a way to save on tax if you own an investment property. And it's sometimes presented as a reason in itself to invest in property. However, the truth is negative gearing should be at most an advantage to consider for investing in property, along with the potential disadvantages. To take advantage of negative gearing benefits, you should understand how negative gearing works and the deductions you could claim. This information is general in nature so do not implement this strategy until you speak to your tax advisor so you can understand how negative gearing would apply in your situation.
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