Negative gearing explained
We explain what negative gearing is, how it works, along with the benefits and risks that come with this property investment strategy.
If you’re interested in investing in property, chances are you’ve heard the term ‘negative gearing’ thrown around.But what is negative gearing in Australia and how does it work?
Let’s take a look at how negative gearing works, along with the benefits and risks that come with this property investment strategy.
What is negative gearing?
The term gearing refers to the process of borrowing money to buy an asset, like an investment property. So, what does negative gearing mean? Negative gearing is a type of financial strategy where the costs associated with owning and maintaining an investment property equate to more than the rental income generated by the property. Essentially, negative gearing means that your investment property is making a loss because the associated income isn’t enough to cover the expenses.
On the flip side, your investment property is positively geared when the rental income exceeds the expenses that come with running the property.
How does negative gearing work?
While making a loss on an investment property might not sound like a good idea, negative gearing can be a tax-efficient investment strategy. Here’s how it works.
Let’s say that the rental expenses for your investment property, e.g., interest rates, council rates, strata fees and maintenance costs, come to an annual total of $30,000, but the property itself only generates $20,000 in rental income. Based on this, your property would be running at a $10,000 loss each year.
As an investor, you can claim this $10,000 loss against your taxable income. So, if you earn an annual salary of $100,000, your taxable income would be reduced by $10,000 to $90,000.
What rental expenses can I claim?
It’s important to have a good understanding of what rental expenses you can and can’t claim, and how you need to write them off as a tax deduction.
Here are some examples of expenses that you claim as an immediate deduction:
- Advertising for tenants
- Body corporate or strata administrative fund fees and charges
- Council rates, water charges and land tax
- Cleaning, gardening and lawn mowing
- Pest control
- Insurance (building, contents, public liability and loss of rent)
- Home Loan interest expenses
- Property management fees and commission
- Repairs and maintenance
- Legal expenses
In some cases, you might need to claim the following expenses as a deduction over several years:
- Repairs and maintenance unrelated to wear and tear or damage
- Capital improvements
- Borrowing expenses
Visit the ATO’s website for the latest information on what you can claim and how to claim the expense as a deduction.
Benefits of negative gearing
There are several potential advantages to negative gearing in Australia, including:
- Tax deductions: As an investor, negative gearing allows you to deduct the loss made on an investment property from your taxable income, potentially reducing your overall tax liability. This can be beneficial if you’re a high-income earner as you can reduce your tax liability by offsetting your rental property losses against your other income.
- Capital growth potential: Investors can use negative gearing with the expectation that the property will appreciate in value over time. The capital gains realised upon selling the property can outweigh the losses made during the holding period, resulting in a net financial gain. In Australia, capital gains on properties held for more than a year are eligible for a 50% discount on the capital gains tax.
- Wealth accumulation: Negative gearing can be part of a long-term wealth accumulation strategy. The tax benefits, combined with the potential for property appreciation, could help you build wealth over time.
Drawbacks of negative gearing
Negative gearing also comes with its fair share of risks and disadvantages that are important to consider before pursuing this type of investment strategy:
- Cash flow strain: Since a negatively geared property generates less income than its expenses, it’s up to you to cover the shortfall from other income sources. This can put significant strain on your personal finances, especially if you have multiple negatively geared properties or other financial commitments.
- Interest rate risk: Changes in interest rates can significantly impact the cost of borrowing. If interest rates rise, the cost of servicing the mortgage increases, potentially increasing the negative cash flow from the property and leaving you vulnerable to greater financial strain.
- Economic and regulatory changes: Changes in economic conditions, government policies or tax laws can impact the attractiveness and profitability of negatively geared properties. For example, changes to negative gearing tax benefits or capital gains tax concessions could reduce the financial advantages of this strategy.
- Long-term commitment: Real estate is along-term investment. The benefits of negative gearing, like property appreciation and capital gains, typically accrue over a number of years. You need to be prepared for a long-term commitment. You could also face liquidity issues if you need to sell the property quickly.
While negative gearing might work for some property investors, it also comes with a range of risks that are important to factor into your decisions. Be sure to carefully consider your own financial circumstances and long-term goals, and talk to a qualified tax professional or mortgage broker for tailored advice before committing to a negatively geared property investment strategy. If you’re keen to diversify your investment portfolio with property, check out our blog on the path to property investment for a step-by-step guide on investing in real estate.
Otherwise, if you’re after a loan to help you purchase an investment property, check out our new buy a home offering at Unloan.
