Negative Gearing – Back to Basics
If you have some sufficient money to invest; we suggest you consider negative gearing.
Negative gearing has been in the spotlight as a key issue in the Federal Election campaign so we felt it may be a good time to remind you about how it works.
One thing we can tell you is, at the moment, negative gearing is still feasible, and is still being used by thousands of property investors across Australia as a means of making their investment into residential property more affordable.
Even the Labor Government, if elected, has said that they would NOT change the negative gearing laws retrospectively, meaning, that all of you that are currently negative gearing some properties, you should not be impacted, regardless of which party wins the election.
Negative gearing makes property investment more affordable by reducing the cash flow impact of owning an investment property.
What is Negative Gearing?
Negative gearing helps property investors as it allows them to reduce the amount of taxes payable on other income. In 2013-2014, there was an estimated of 60% of investors and 2 million landlords who suffered losses in property.
Negative = Loss (where the income generated by a property is LOWER than the costs of owning it)
Gearing = Borrowing (ie, the loan you take out to purchase the investment property. Interest on this loan will be one of the main expenses in owning your investment property)
Negative Gearing = the cash loss you make from your investment property, usually due to the interest expense on borrowings.
In negative gearing, the loss incurred on an investment property reduces the tax payable on your other income sources (salary, dividends, etc). This greatly helps when it comes to managing one’s household budget more effectively with more cash in the bank.
Another important thing, to consider when talking about property investment, is the Capital Gains tax discount. Introduced in 1999 by the Howard government, the Capital Gain taxes (CGT) discount sees only half the profits from the sale of property investment as taxable. Elaborating it with an example, if an investor made $120,000 selling a house, only $60,000 of it will be taxed. The CGT discount was introduced to boost the investments in properties in Australia and so far has cost the budget approximately $6 billion in the past financial years.
How Negative Gearing Works?
In order to explain how negative gearing can work for you in the longer run, let us consider the following example.
Suppose you purchase an investment property at $550,000 and borrowed a loan of $500,000 with an interest rate of 7%. Interest payable on the loan will account for $35,000 annually.
Your per week income on your rental property is $500 which sums up to an annual rental income of $24,000.
Working on this example, you are paying $35,000 as interest on your loan but only earning $24,000 as income on rent. This means you are falling short of $11,000 which seems like a bad investment at the moment. But if all goes well, chances are your property investment will be going up and will value to more than it does now in the coming years. Let’s assume its value goes up by 10% annually increasing its net worth by $55,000. At the end of the year, you will pay off the $11,000 in interest but you will also be $44,000 richer than you were a year ago because the value of the investment property went up.
Benefits of Negative Gearing and Property Investment
The main advantage of negative gearing is that it offers many tax benefits.
According to the Australian law, if your costs exceed the income you earn from your property, you can claim deductions on your maintenance costs, and borrow from your overall income as long as your investment property continues to produce income.
Secondly, investors are also entitled to a concession of 50% as capital gains tax discount if they are able to hold their investment property for more than a year before selling.
It is understandable that this may seem like a big step, especially if the market goes down, but is also foolish not to invest if you have the money for it. Real estate market going down is a very rare circumstance and therefore must not stop you from acting smart.
If you have any questions about how negative gearing could work for you, in terms of investment property ownership, please do not hesitate to call us. We can:
- Explain negative gearing works in more detail
- Show you examples of how it could work with you
- Work in conjunction with your accountant to ensure the cash benefits flow to you as soon as possible