Negative gearing is a term that is often heard in the news, but it can be confusing to understand.
What does it mean? Is it good or bad? And can it help me to grow my investment portfolio?
In this blog post, we will provide a simple plain English explanation of negative gearing and answer some of the most common questions people have about it.
Here’s what we cover:
- What is Negative Gearing?
- Negative Gearing vs. Positive Gearing – What’s the Difference?
- What is an example of Negative Gearing?
- What Types of Properties are Positively Geared?
- Is Negative Gearing Going Away?
- Bonus: 5 Massive Changes Affecting Landlords and Renters in 2022
- Is Negative Gearing right for you?
Let’s dive right in.
What is Negative Gearing?
Negative Gearing is an investment strategy that involves purchasing a property that has holding costs greater than the rental income it generates. While this means you are making a loss, you can claim the loss in income as a tax deduction.
A property investment strategy based on negative gearing relies on increasing property values to offset the losses made from holding the property.
Negative Gearing vs. Positive Gearing – What’s the Difference?
Negative Gearing means you are paying more interest and costs than the rental income you are receiving.
Positive Gearing is the opposite – it’s when the interest and total costs of your property are less than the income you make, which gives you a profit each month.
Negative gearing may not make a lot of sense if you’re looking purely at the cash flow generated from your investment property. However, there are other benefits to negative gearing which can make it a winning part of your investment strategy.
Let’s take a look at a simple example of negative gearing.
An Example of Negative Gearing
Let’s walk through a simple example of someone who owns a unit that is negatively geared. Sandra is renting out an apartment.
Their income and expenses could look something like this:
|Annual Income||Annual Expenses|
|Rent||$30,000||Loan at 4.50%||$28,000|
|Body Corp Fees||$2,000|
|Total Income||$30,000||Total Expenses||$46,500|
|Total Income / Loss||-$16,500|
You’ll note that we’ve included depreciation in this example. While you don’t directly pay for depreciation, you will need to pay to maintain the property so we’ve included it in our calculations.
In this example, Sandra’s property is negatively geared by $16,500 per year:
The next thing we need to do is take a look at her tax returns. Any loss from an investment property can be deducted from your taxable income.
For this example, we’ll assume that Sandra is making $110,000.
The $16,500 loss will be deducted from her income, so she will pay tax on only $93,500.
This would reduce her tax payable by $5,362.50.
When we factor this into her annual losses for the property, the total loss per year would be $11,137.50.
The other benefit is the depreciation cost for the property – Sandra wouldn’t physically have to fork out $12,000 per year so she would actually be up around $862.50 per year from her tax refund.
That means that after her negative gearing benefits the property is actually slightly positively geared. However, this is looking at an ideal situation. If the property has any vacancies and her rental income gets reduced, or her interest rates increase, the property can become negatively geared very quickly.
But the real benefit of negative gearing is capital growth.
What happens if Sandra’s property increases in value by 4% in 1 year?
Depending on how much capital Sandra has invested, this can translate into a very good return on investment:
|Cash invested||Borrowing||Purchase Price||Capital Gains||Return on cash|
However, it goes both ways. If the property value decreases then it compounds the losses:
|Cash invested||Borrowing||Total Invested||Capital Gains||Return on cash|
What are the Benefits of Negative Gearing?
The main advantage of negative gearing is that you can offset the loss from owning a property that is not generating enough rent to pay for its expenses. This decreases your taxable income, which means your tax liability will decrease. This is an especially useful benefit for those who are on a high income.
The tax benefits can assist with your short-term cash flow while you are waiting for the property to increase in value. Depending on the amount of cash you have invested in the property and the capital growth, this strategy can deliver a high return on investment.
What are the Downsides of Negative Gearing?
The main downside for property investors is that a negative gearing strategy is reliant on capital gains. If the property value decreases, then the investment will make a loss. This problem is compounded if you are highly leveraged and you own multiple properties.
The other main downside is for people who are looking to buy a home to live in. Negative gearing can inflate property values since investors are willing to buy property that won’t generate an income. However, the impact of negative gearing is small in comparison to other factors such as zoning regulations and interest rate cuts.
Is Negative Gearing Going Away?
Negative gearing has always been a hot topic in the Australian property market. There have been talks for years about reform, but it never seems to go anywhere. Last year Labor suggested that it would halve the CGT discount, but they rapidly backtracked when they realised how many votes they would lose.
Like it or not, Australians love property investing and negative gearing is unlikely to go away any time soon.
Bonus: 5 Massive Changes Affecting Landlords and Renters in 2022
Being a landlord is not just an investment like shares; it means you are actually providing housing for another human being. The following 5 reforms have been implemented to help make renting a fairer arrangement for tenants and landlords. So what are the reforms?
- Rental bidding. Rental bidding is where the property goes to the highest bidder – effectively pricing out most people from the rental market.
- Minimum standards for dwelling. This means that rental properties will have to meet certain basic standards before they can be rented out. So, for example, heating, safety and, in some cases, security.
- Property modification. Most times, landlords don’t allow tenants to do modifications such as hanging a picture or doing a vegetable garden at the back. This reform will allow people to make (reasonable) modifications as long as they put the property back to what it was when they initially leased it out.
- Pet inclusions. This is a huge one because a lot of people have pets, and they form part of their family. With this new reform, landlords will have to establish grounds for refusing pets instead of just saying ‘no’.
- More secure leases. This applies more to New South Wales, where landlords could easily get rid of tenants without establishing grounds for eviction. Now they have to give valid reasons, for example, if they are moving back into the property.
These reforms differ slightly from state to state, so make sure you check the specific reforms in your state.
Is Negative Gearing Right for You?
All investments come down to your individual situation and circumstance.
If you are looking at purchasing an investment property in Brisbane, or across Australia, our team at Hunter Galloway can help.
I’m Jayden Vecchio, and our team here at Hunter Galloway helps property investors with navigating the investment lending process.
What we do is make it simple to get through the home loan process, and with our team of experts, we will help walk you through the process to complete your first home buyer’s grant application. If you are building your first home, we can help walk you through the investment loan process.
Our service does not cost you anything as we are paid by the lender when your home loan settles.
To chat about your deposit, lending and investment lending options book in a time to sit down with us, or feel free to call on 1300 088 065.
The information on this page is general in nature and should not be considered as advice. Before you act on this information, you must seek independent legal and financial advice.