The term ‘negative gearing’ has been thrown around by politicians, parents and finance bros for years, but what does the term negative gearing mean? Whether you’re looking to invest in property or get your head around options for the future, we explain negative gearing so you can keep up with the conversation.
Negative gearing explained.
In a nutshell, gearing is borrowing to invest. Positive gearing is when the rent you receive for an investment property pays more than your property-related expenses.
Neutral gearing? Neutral gearing is, you guessed it, when your rental return is the same as your property-related expenses.
Finally, negative gearing – a term you may hear used a LOT – is when you spend more on the property than you make back on the rent, so you're running at a loss.
While this sounds far from ideal, this ‘loss’ has the ability to lower your taxable income. For this reason, having a negative geared property is considered a strategic – and appealing – move for many Aussie investors.
Reasons for negative gearing property.
- Potential for capital growth.
- Reduction to your taxable income.
- Rental expenses can be claimed as tax deductions.
The idea is that while you're losing a little now, the property's value will increase over time – this is your capital growth. When you do eventually sell, you're likely to make a profit.
Another positive for most is the tax benefits, a bonafide instant perk.
That ‘loss’ we talked about? investors can use that rental loss against their employment income to reduce their taxable income, potentially paying less tax.
Check the ATO website to see what you can and can’t claim.
And now for the risks of negative gearing.
While an investment property that is negatively geared is sounding pretty sweet, we can’t sugarcoat the fact that there are risks involved. Investing in property, especially with negative gearing, isn't all smooth sailing and there are some potholes you need to watch out for.
Cash flow issues.
Basically, if your rent isn't covering your expenses, you're going to have to dig into your own pockets. And trust us, that can get old, fast.
Your tenant could decide to move out and you might not find a new one for a few months. You're still paying the mortgage, rates, and everything else, but no rent is coming in, which could get stressful.
Market fluctuations.
Property markets can be very unpredictable. Just because your property's value went up last year doesn't mean it'll do the same this year. It’s important to be prepared for the possibility that it could go down and impact your investment.
Interest rate changes.
Interest rates can change. And when they go up, your mortgage payments go up, too. Suddenly your repayments could be hundreds more a month, which can mess with your budgeting.
Unexpected maintenance cost.
Pipes burst, roofs leak, and appliances die. Sadly, these things happen – and they are expensive. It's important to have money set aside for these surprises.
Let's talk taxes: your negative gearing hack guide.
We've covered the basics of negative gearing, now let's dive into the juicy part: taxes. Claiming all your eligible deductions could significantly boost your negative gearing strategy, so here's a few helpful pointers.
Interest payments.
This is a big one. The interest you pay on your investment loan is tax-deductible. That means, if your mortgage interest is $15,000 a year, you can claim it. Just be sure you keep all your loan statements for tax time.
Repairs and maintenance.
A leaky roof, broken hot water system, and a new paint job are all potentially deductible. Just remember that repairs fix existing problems, while improvements add value. Repairs are deductible, improvements aren’t right away.
Travel costs.
If you're traveling to inspect your property, you can potentially claim costs such as petrol, train tickets and even flights.
But – and this is a big but – it must be directly related to managing your property. A weekend getaway disguised as a property inspection won’t fly.
Property management fees.
Property managers are lifesavers. They handle everything from finding tenants to dealing with repairs, and their fees are deductible. If you find the idea of being hands-on with your property too much to handle, consider looking into someone to do it for you.
Body corporate and rates.
If your property is in a strata building, those body corporate fees are deductible.
Depreciation.
This is where things get a bit technical, but it's worth it. Depreciation is the decline in value of your property's assets over time – think carpets, appliances, even the building itself.
Capital gains tax.
Once you sell your property any net profit from the sale – think of the capital growth we mentioned earlier – will be taxed. This amount is your Capital gains Tax (CGT), which is determined by the difference between the amount you paid for the house versus the amount you sold it for.
Crunch the numbers: is negative gearing worth it for you?
Here's a simple way to calculate if negative gearing makes sense for you:
1. Add up your total rental income.
2. Subtract your total property expenses.
3. Subtract depreciation.
Example:
$500/week rent, $600/week expenses = -$100/week (-$5,200/year).
With $15,000 depreciation, you can offset $20,200 from your taxable income.
Rental Income – (Total Expenses + Depreciation) = Tax Offset.
While negative gearing works for some Australians, it’s not for everyone. Chatting to a financial advisor can help you decide the best investment strategy for you.
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This article is prepared based on general information. It does not take into account individual financial objectives or needs and is not financial product advice.