Negative Gearing & Property
While Negative Gearing is commonly associated with investment or 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 situation 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 Australia. 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 only expected to generate profits 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 cash flow 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.
Read More - Negative Gearing Traps Exposed
Let’s assume you buy a flat for $600,000 in your personal name and borrow $400,000 (a conservative 67% LVR) to fund the purchase. The
funds are borrowed at an interest rate of 5.5% and the weekly rent is $600 or $31,200 a year. Ongoing costs including agent’s fees,
rates, insurance, repairs and maintenance and other expenses are summarised below:
Sample Profit & Loss Statement on the Property
Rental Income - 52 Weeks @ $600
LESS : Expenses
Interest $400,000 @ 5.5%
Repairs & Maintenance
Agents Fees - 7% of Rental Income
Body Corporate Fees
Net Tax Loss (before Depreciation)
Less: Depreciation (based on Depreciation report)
Net Tax Loss
So, although the Gross yield is a healthy 5.2% , after annual interest repayments and all associated expenses you have actually ‘lost’ $5,200 during the year, although the actual 'cash' outgoings are limited to $800 as depreciation is a non-cash deduction.
In this example, you will reduce your taxable income by $5,200 through incurring a loss on the investment property. If you had a taxable income greater than $180,000 in the 2020/21 financial year you would be on the highest marginal tax rate of 47% (including the Medicare levy) and this tax deduction would have the ultimate effect of reducing the after tax 'cash' cost of the property from $800 to a net annual positive 'cash' income $1,644 or $31 per week. The tax treatment has turned a cash outlay into a positive cash flow. If you are on a lower marginal tax rate of tax of 32.5% (incomes between $45,001 and $120,000) the annual cash cost on the investment would be reduced from $800 to a positive cash income of $994 (or $19 per week). The 2021/21 individual tax rates are:
Tax on this Income
|$0 - $18,200||Nil|
|$18,201 - $45,000||19c for each $1 over $18,200|
|$45,001 - $120,000||$5,092 plus 32.5c for each $1 over $45,000|
|$120,001 - $180,000||$29,467 plus 37c for each $1 over $120,000|
|$180,001 and over||$51,667 plus 45c for each $1 over $180,000|
|* The above rates do not include the Medicare levy of 2%|
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:
- 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 cash flow 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 call our office today.
Keep Excellent Records for Your Investment Property.
As accountants, we are committed to helping clients simplify their record keeping and aim to minimize tax return preparation costs. If you own an investment property we recommend you keep all your rental property tax records in one place.
Historically we have found the calculation of capital gains on the sale of property to be a source of major headaches and frustration due to the loss of source documents. Make sure you keep your purchase and sale records for capital gains tax purposes along with all the other information you need to prepare your annual tax returns. There are various rental property software modules on the market and some will also allow you to analyse potential investment property purchases through property analysis modules.
Over the years we have guided numerous clients through the haze and maze of buying a negatively geared investment property. The tax and wealth creation strategy doesn't work unless you have the right property and ownership structure. If you're looking to know more about negative gearing we invite you to contact us today.