Negative gearing: Special report
With all this talk of negative gearing in parliament and about town we thought it apt to prepare a special report on negative gearing for our readers.
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In short, borrowing to invest is known as gearing. You can negatively gear for both shares and property in the Australian context. If your interest on a loan and running costs of the property add up to more than your investment’s income, you are making a loss on the property, referred to as ‘negative gearing’. Given that much of the recent talk to do with negative gearing has focussed on property investment this article primarily addresses the key concepts to do with property related negative gearing.
It may seem unintuitive, but the reasoning behind a negative gearing strategy is to get into the market early, and increase your investment income over time to eventually cover your expenses. Until that time, you are generally able to claim your net loss as a tax deduction against your regular income. This tax saving can be paid as a refund at the end of the financial year, or you can vary the tax withheld from your pay during the year instead.
An example of negative gearing tax savings
You are a PAYG employee on a $70,000 salary, and own a rental property. The property collects $15,000 a year in rent, but costs $25,000 a year in interest and running costs, leaving a $10,000 loss on the property overall. This reduces your taxable income to $60,000, thus saving you 30% tax, or $3,000 on the reduction.
This example makes it clear that the after-tax loss on negative gearing is $7,000, and is moderated by the tax reduction you receive.
Taking the example above, let’s also look at what happens when you claim depreciation benefits on the property. The rental income is still $15,000, costs are $25,000, and we’re adding in a depreciation claim of $4,000. This means your cash loss for the year is $10,000, and your net rental loss for tax purposes is $14,000. Your taxable income now drops from $70,000 to $56,000, with the 30% tax saving now being $4,200. This has reduced your after-tax loss to just $5,800.
- The interest on the loan
- The costs of setting up the loan, including establishment fees
- Letting agent fees to manage the property
- The cost of advertising for tenants
- Council rates and land tax
- Owners’ Corporation levies
- Insurance premiums (for example landlords’ insurance)
- Depreciation of fixtures and fittings, including furniture
- Repairs and maintenance
The key benefit of negative gearing is that it enables you to offset costs associated with your loan and renting the property against your tax bill — and at the highest rate of tax that you pay.
Even if you’re saving on tax by making a loss on your investment property, you are still losing money. However, investors still buy negatively geared property because the growth in value on the property will usually surpass the holding costs. When you do decide to sell the property, you will need to pay a capital gains tax on the sale’s profits, but the tax benefits from a negatively geared property help you hold more investment properties without changing your lifestyle.
The flipside of all this is a positively geared property, or one that is running at a profit. Many investors rely on capital gain when selling to make a profit on property investments, however some will hold their properties for long enough to see them shift to being positively geared through rent increases. This happens as loan amounts are unchanged, and eventually rent income will surpass the holding costs of a property.
Other investors will buy property with high rent returns from day one, making them positively geared from the get go. These properties may see lower capital growth than negatively geared properties. Through picking a great property, it may even be possible to get the coveted combination of a property with high growth rate and high rental returns.
While positively geared properties don’t come with the same tax benefits their negatively geared counterparts afford, remember the goal of investing is to turn a profit, not avoid tax. As such, positively geared properties are great investments when they have high capital growth too.
As an investor, you should have a strategy that evaluates several lenders to realise your investment goals. This is because not all lenders will take negative gearing benefits into account when assessing your ability to afford a loan, and most will not use the full value of your rent income in an assessment. It is worth noting that investment lending criteria has toughened somewhat in the 12 months to date. For further information on these changes, refer here or speak to a Naritas credit adviser.
No, you cannot roll your home loan into your investment property for a tax deduction.
The Australian Taxation Office (ATO) takes into account the purpose of your loan, not what it’s secured on. This means moving the loan over won’t affect what the funds were originally borrowed for, thus disqualifying the interest from being tax deductible.
Before making any investment decisions regarding your finances, seek professional financial advice specific to your situation. Typically the kinds of advisers an investor would seek to gather opinions from would include:
- A licensed tax agent and/or accountant regarding tax implications of various portfolio and finance structures.
- A solicitor with respect to considerations to do with wills & trusts, but also to do with due diligence aspects of the purchase and finance.
- A quantity surveyor to assist with preparing tax depreciation reports.
- Professionals who can assist with various aspects of the due diligence including licenced valuers as well as building and pest inspection companies.
- A credit adviser who has specialist knowledge of investment property finance and who is capable of project managing the various parties listed above as well as engineering the finance structure for the negatively geared purchase.