Negative Gearing Explained
You hear about people making money from investment properties all the time, plus you may have been a renter for years and know just how much money you contributed to your landlord’s investment portfolio. Therefore you may be wondering how you can get in on some of the profits from an investment property but first you will need to know more about exactly what negative gearing is, how to successfully negatively gear an investment property and whether negative gearing is the right option for your financial situation to earn you the best return.
Gearing is Borrowing
Very few people who buy an investment property buyer with their own money because when you borrow to invest you are able to take advantage of opportunities which you might not otherwise be able to afford. However this doesn’t mean that you should go in without a budget because you need to make sure you are borrowing a sensible amount for what you can afford and what you can expect to gain from your investment because as the old saying goes the more you borrow the more you stand to lose, whereas in the case of investments you would rather that the more you borrowed enabled you to gain more.
Negative gearing is perceived as a way to save on your tax but you can only make a tax deduction using your investment property if you make a loss on your investment and tax deduction or not a loss is a loss. For example if you buy a unit for $300,000 where you put in $50,000 of your own money and borrowed the remaining $250,000 that you need, the interest you are charged at 7% each year is $17,500, whereas her weekly rent is $3000 or $15,600 a year so effectively you make a loss on your rental yield.
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Investment Deductions and Allowances
When you own an investment property you also need to cover ongoing costs such as rates, water, insurance, maintenance and appreciation and you will get an allowance of $2600 each year. Using the example above after your expenses your income for the year will be $13,000 making your rental yield equivalent to 4.3% and since you have paid $17,500 in interest repayments you have actually lost $4500 over the year.
However you can further reduce your tax liability on your assessable income by the amount of loss you make on your investment property. For example if you are on the highest marginal tax rate of 46.5% then this tax deduction will actually be able to reduce the real loss you make on the property from $4500, to become $2408 because $4500 x 46.5% is $2092 offering you good savings at tax time. If you were on a lower tax rate of 31.5% for example being taxed at this lower rate means that your after-tax loss would be reduced from $4500-$3083.
While most investors will accept some sort of loss on their investment because they expect to be compensated by a capital gains in the property value down the track you need to make sure that you have the financial flexibility and cash flow now to be able to cover such losses. It also pays to be able to hold on to your investment property for the long-term because long held capital gains are only half assessable meaning you will lose less of the profits from your sale to capital gains tax if your investment property is a long-term investment.
Investment Compensation
As well is making sure you are making a profit over the long term, all the right sort of loss, you also need to make sure that the money you invested in your investment property is working harder for you than it would have if you simply left it in a savings account. If you deposited the $50,000 you put into your investment property in a bank term deposit at 6% and paid tax on that interest you would earn $1605 net. This means that you need to be making a net capital gain of $4013, which is your real loss of $2408 plus your would-be gain of $1605. For you to net to the gain of $4013 your investment property needs to appreciate in value by $5228 or an appreciation equivalent to 1.7%.
This means that if the property market is stagnant or only making slight growth then your investment property is not going to earn you any more than a term deposit would have, however if your property is appreciating in value than you have made a sound investment. This is why property investments are best as long-term investments because over the long term property prices tend to stay ahead of inflation, and the reserve bank of Australia aims to keep inflation around 2 to 3% meaning that you would easily make your gains of 1.7%.
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Property investors need to be particularly aware of buying in a market where prices are over inflated because your rental yield will be low but you will need a high outbreak even rate of appreciation. There is also nowhere to go in the future because the value of your investment property is already high and is likely to stay flat or even go down in the short term. At the same time the property market, property values and interest rates are all directly linked and if you are investing in property market where prices have declined then you are more likely to see effective results from negatively gearing the property.
There are many different ways that people can invest in property. While everyone will usually have the same goal you should realise that you can take many paths to reach that goal. Some people may choose to contribute a lot of their own money so that they will make a profit from the investment. Other people may want to negatively gear the property so they can take advantage of some of the tax benefits of owning a property.
What is an investment strategy?
Before we explain what negative gearing is you should know about investment strategies and how they will affect the way you manage your loan. The investment strategy that you choose will usually depend on the amount of money that you will be able to commit to the investment property. If you are able to commit a lot of money to the investment property then you may want to positively gear the house. This means that you will earn money from the investment. If you have to borrow a lot of money to pay for the property then you will want to negatively gear the property.
What is Negative Gearing
Negative gearing is a great way for people to invest in property while still getting some benefits on the money that they spend. This section of the article will explain what negative gearing is and what the alternatives to it are:
- Negative gearing. Negative gearing is when you spend more money on the investment property than the amount that you make from rent. The money that you spend on the property will then be tax deductible.
- Alternatives to negative gearing. While many people will decide to negatively gear the property you can choose to invest in other ways. One of the main ways people will invest instead of negative gearing is positively gearing. This is when you actually earn money from the investment. While positively geared places are a great way to make money you will need the initial money and you will not receive any of the taxation benefits of negative gearing.
How do you negatively gear a property?
Negative gearing is a great way for people will little money to invest in property. It works by allowing you to make deductions on your tax. The costs that you can deduct from the house are the interest that accumulates on the loan, the maintenance costs or the house and many more. You will be able to make the deductions at the end of the year or during the year if you are careful. If you are making the deductions from your wage during the year then you should be sure that you have predicted the amount the house will cost you accurately. If you do not then you may end up with a large tax bill that you may find difficult to pay.
Negative gearing is a great way for people that do not have a lot of spare money to invest in the property market. By negatively gearing the property you will be able to deduct many of the costs that are associated with the house from your tax. By doing this you will be able to save more money on your home and reduce the amount of money that you will pay overall.
What are the Benefits of Negative Gearing
By negatively gearing a property you will receive a number of benefits. This section of the article will explain what benefits you will receive and how you can get the most from negative gearing:
- Tax benefits. The main benefit you will receive from negatively gearing your investment property is that you will be able to get a range of tax benefits. Some of the tax deductions that you will be able to receive from negative gearing will be on the costs of body corporate, the interest that is charged to your loan and many more.
- Know how much you need to pay. By knowing exactly how much you will be earning from the property and how much you will have to pay onto the property you can make sure that you pay as little as possible. For example, if the costs from your property is only $10 a month then you will still be able to get all the benefits of negative gearing.
Gearing
When you are looking to buy an investment property you will have to decide what type of gearing you will use. The two types of gearing are:
- Negative. Negative gearing is when the amount that you earn on a property is less than the amount that you are paying onto the loan. While you are running at a loss with the property there will be many advantages of negative gearing that will be explained later.
- Positive. A positively geared property is when the amount that you receive in rent is more than the amount that you spend on the property. Essentially, if you make a profit from the rent then you have a positively geared property.
Investment Expenses that you can Claim as a Deduction
When you negatively gear a property you will be able to make some tax deductions that will help you save money. The tax deductions that you will be able to make are:
- Revenue. When you negatively gear a property you will be able to claim the interest that is charged on the loan as a tax deduction. as big as this is you will also be able to claim ongoing maintenance and expenses such as agent’s fees, council fees, advertising charges, bank fees, body corporate fees, cleaning expenses, gas, water, gardening and insurance.
- Claims for capital items. If any items that are used in the rental property are functioning then they too will be able to be included in the deductions. This will include hot water heaters and other appliances.
- Claims for building allowances. The owner will also be able to claim depreciation on capital works at a rate of 2.5% for 40 years.
Risks of Gearing
While gearing has a variety of benefits that could potentially save you a lot of money you may find that there are some disadvantages. The risks of gearing are:
- Risks. When you borrow money there will always be a risk involved. If the interest rates rise then you may find that you are unable to make repayments. However, the smart investor will plan ahead for such occurrences.
- Minimise risk. If you are thinking about gearing a property then there are things that you can do to minimise the risk. Firstly, you should look at choosing the right investment property. If you do this right then you will not have to worry about losing money. Furthermore, you should also have the income to account for times when there are no tenants or major repairs need to be done. If you do both of these things then you will avoid the risk of borrowing money.
If you are looking to buy a property you should look at how you are going to gear the property. If you negatively gear a property then you will find that you may get many advantages from doing so even though you are actually losing money on the property. Know how you are going to gear and build as much equity as possible.
Related posts:
- How to Negative Gear with an Offset Account
- Negative Gearing Tax Implications with a Commonwealth Bank Home Loan
- Refinancing Tax
- Investment Property Cash Flow
- How Much Should you Borrow
- Interest Management Loans
- Guide To Investment Property Tax
- No Deposit Investment Loan
- Investment Property Benefits
- 4 Key Considerations When Buying an Investment Property
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