What is Negative Gearing?
Negative Gearing by definition is where you borrow to acquire an investment and the interest and other tax deductible costs you incur exceed the
income you receive from the investment.
While Negative Gearing is commonly associated with rental properties, it can also be applied to other types of income-producing investments such as shares and managed funds using what is often called ‘margin loans’. In terms of property investment, negative gearing refers to a 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 this country. 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, it can be a risky business because while gearing can amplify your gains, it can also magnify your losses. There is no better example than the 2008 US sub-prime lending crisis where the collapse of the US Property Market left some 30% of mortgagees with a loan balance higher than the value of their property.
If you negatively gear property, you need to understand some important points:
Let’s assume you buy a unit for $400,000 in your personal name and borrow $350,000 to fund the purchase. The funds are borrowed at an interest rate of 8% and the weekly rent is $450 or $23,400 a year. Ongoing costs including agent’s fees at 7% of the rent, rates, insurance, repairs and maintenance and other expenses are summarised below:
Profit & Loss Statement
|Rental Income – 52 Weeks @ $450||$23,400|
|Interest – $350,000 @ 8%||$28,000|
|Repairs & Maintenance||600|
|Agents Commission – 7% of $23,400||1,638|
|Body Corporate Fees||1,000||$34,400|
|Net Profit (Loss)||(11,000)|
After expenses, net income for the year will be $17,000 ($23,400 minus $6,400), equivalent to a net rental yield of 4.25%. However, annual interest repayments are $28,000, so you have actually ‘lost’ $11,000 during the year ($23,400 minus $34,400 = -$11,000).
In this example, you will reduce your taxable income by $11,000 being a loss on the investment property. If you had a taxable income greater than $150,000 in the 2008 financial year you would be on the highest marginal tax rate of 46.5% (including the Medicare levy) and this tax deduction would have the ultimate effect of reducing the after tax loss on the property from $11,000 to $5,885 or $113.17 per week.
If you are on a lower rate of tax of 31.5% (including Medicare levy) the after tax loss on the investment would be reduced from $11,000 to $7,535 (or $144.90 per week).
How We Can Help
The real benefits of negative gearing are only realized 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:
If you are interested in finding out more about negative gearing call our office today.
Keep Excellent Records for Your Investment Property.
As your accountants we are committed to helping you simplify your record keeping and aim to minimize your tax return preparation costs.
If you own an investment property Rent Manager will 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. Rent Manager keeps your purchase and sale records for capital gains tax purposes plus all the information you need to prepare your annual tax returns. It also allows you to analyse potential investment property purchases through the ‘property analysis’ module.
Rent Manager includes the following features:
Rent Manager is the perfect tool to manage your property, makes completing your tax returns easy and gives you peace of mind that you have the capital gains tax information you need when you finally come to sell the property. Copies are available from our office.