Negative Gearing

A property is negative geared if it is bought with borrowed funds and the net rental income (after deducting other expenses) is less than the interest on the borrowings. If you have this kind of rental loss, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income, such as salary, wages or business income. If this means that your rental expenses would entitle you to a tax refund, you may be able to reduce your rate of withholding.

If you are thinking of buying a negatively geared rental property, it is important to remember that while you may get an immediate benefit from negative gearing, you may have to pay tax on your property when you sell it. This is because any profit you make on its sale will be subject to Capital Gains Tax.

The reason negative gearing can be attractive is that under the current Australian Taxation Law, an investor may be able to claim a deduction for the loss, which can be offset against other taxable income, such as salaries, business income or other investment income. (Provided it is an Australian income producing investment.) Of course, if there is no growth in the value of the asset, you could lose money even after the tax benefit is taken into account. Hence, the importance in sourcing quality investments with good capital growth potential.

Negative Gearing isn't suitable for all investors. Although it can lower your tax liability, the tax implications will depend on your personal situation, and the type of investment you choose. You should seek qualified independant financial advice before investing and gearing.

Positive Gearing

Positive Gearing occurs when you borrow to invest in an income producing asset and the returns (income) from that asset exceed the cost of borrowing.

An example would be if you borrow to invest in shares or property, and the market then boomed to an extent that the increased value and returns of your asset exceeded the expenses of the loan.

Deduction checklist for investment properties

Below is a checklist of typical deductions directly related to rental properties that can be claimed:

• Body Corporate Fees
  
  
• Borrowing Expenses (For example, stamp duty and legal fees on mortgage)
  
  
• Building depreciation (depending on date of construction)
  
  
• Cleaning Costs
  
  
• Council Rates
  
  
• Depreciation of fixtures and fittings (light fittings, carpets etc)
  
  
• Insurance Costs
  
  
• Interest on loans (including interest prepaid up to 12 months in advance) and related bank charges
  
  
• Land Tax
  
  
• Pest Control Costs
  
  
• Property Agent Management Fees
  
  
• Repairs and Maintenance (excluding improvements which are treated as capital and added to the cost base of the asset for capital gains tax purposes rather than being claimed as an immediate deduction)
  
  
• Telephone, postage and stationary
  
  
• Travelling Expenses
  
  
• Water Rates

Benefits of Gearing

The calculation of depreciable items is very specialised and should always be carried out by a qualified professional. Investors should always use an accountant who specialises in property investment to ensure all tax deductions are claimed. Further, National Investment Planning recommends investors use the services of a Quantity Surveyor to ensure maximum deductions of their depreciable items.

When selecting your investment property, there are many factors to consider, one of them is new or existing. There is a major advantage with new property. That is, it allows you to maximise your tax advantages and to reduce the out of pocket costs to yourself to fund the property (see info pack for more details).

When to Negatively Gear?

Taking all these considerations into account, negative gearing is desirable and will create wealth when:

1. An investment's capital growth will be greater than its cash loss (or you expect future profits to more than make up for present losses); and
2. You can comfortably manage the risk associated with returns not being in the form of cash (or delayed until sometime in the future); and
3. You are willing to accept wealth in the form of non-spendable capital gains (or future profits) in the short or medium term.

Negative gearing can generate wealth, and it can do so at higher rates of return on equity than non-leveraged investments. Aside from the primary consideration of whether wealth will grow or not, the desirability of negative gearing will depend on the strength of an investor's cash position, and their individual willingness to forgo cash now for cash later.

Negative gearing can produce high investment returns in the long term in a tax effective way if the property investment is carefully directed into areas of high capital growth potential. From this, it stands to reason that negative gearing can serve as a very powerful instrument in building assets for retirement.

Negative Gearing - Key Points

• Invest in areas of good capital growth potential - An investment properties capital growth will more than make up for its short term cash loss, or future profits will be greater than present losses;
  
  
• You are willing to accept wealth in the form of non-spendable capital gains (or future profits) in a short or medium term.
  
  
• Non-taxed (or delayed tax) capital growth is a far more effective wealth-accumulation mechanism than income which is realised and taxed.

Negative Gearing is often sold as a tax minimisation tool, but really it should be considered an investment enhancement tool.

Further information on negative gearing, positive and neutral gearing, including a look at the nuts and bolts of negative gearing through an example is available in the free information pack.

Contact us for a free personalised assessment to see how negative gearing could work for you now and in the future.

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