In this post, I’m going to break down EVERYTHING you need to know about negative gearing.
What it is.
Why it’s important.
And whether or not it can help with growing your investment portfolio.
Let’s dive right in.
- What is Negative Gearing?
- Negative Gearing vs. Positive Gearing – What’s the Difference?
- Looking at cash flow Negative Gearing might not make sense, but…
- The Kicker for Negative Gearing
- What is an example of Negative Gearing?
- What Types of Properties are Positively Geared?
- Changes to Negative Gearing
- Is Negative Gearing right for you?
What is Negative Gearing?
Negative Gearing is an investment strategy which involves purchasing a property that has holding costs, usually interest and depreciation greater than the rental income it generates. This means you are making a loss, but with negative gearing, the loss in income can be claimed as a tax deduction.
The entire strategy relies on using leverage and increasing property asset values, to offset losses made from holding the property while negatively geared.
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 – and positive gearing means the exact opposite.
Positive Gearing is when the interest and total costs of your property are less than the income you make giving you a profit each month!
So, Positive Gearing is great if you are looking for cash flow, and are less concerned about tax benefits which are why…
Looking at cash flow Negative Gearing might not make sense, but…
Let’s walk through a simple example, of someone renting a unit out with the following income, and expenses.
|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|
This is a common example of negative gearing, and while you don’t pay for depreciation per year you will pay to maintain the property.
In this example, Sandra’s property is negatively geared by $16,500 per year:
- 🔢 If Sandra’s income is $110,000, the $16,500 loss is taken off her income and she will pay tax on only $93,500.
- 🔢 Sandra’s taxable income is reduced by $16,500 which at the 37c tax bracket would reduce her tax payable by $6,105.
- 🔢 In this example, Sandra’s total loss would be $10,395 per year – the other benefit for Sandra is the depreciation cost of $12,000. Depreciation is basically the wear and tear and so Sandra wouldn’t physically have to fork out $12k per year so she would actually be up around $1,605 per year from her tax refund.
In the traditional sense Sandra’s property isn’t technically negatively geared, as Moneysmart say:
Negative gearing is a popular tax minimisation strategy, but remember, you only reduce your tax if you reduce your income. If you are borrowing to invest, choosing a positively geared investment will increase your income and increase your overall return on investment.
The Kicker for Negative Gearing is Capital Growth
For Sandra, after her Negative Gearing benefits the property is actually slightly positively geared… but if her property is vacant and the rental income gets reduced, or her interest rates increase this can turn the property into negatively geared very quickly.
Meaning Sandra really needs to see some positive capital growth to see a return on her cash deposit.
What happens if Sandra’s property increases in value by 4% in 1 year?
|Cash invested||Borrowing||Purchase Price||Capital Gains||Return on cash|
While the total amount you have invested has increased in values, you can make this strategy work, but it can be equally as powerful if the values do not increase. If asset values fall the negative return is equally compounded.
|Cash invested||Borrowing||Total Invested||Capital Gains||Return on cash|
The benefits of negative gearing are:
- ✅ A large majority of properties in the Australian economy are negatively geared, they can help keep rent lower and reduce public housing requirements.
- ✅ Beneficial tax arrangements for investors, and can help grow the wealth of every day Australians.
The main advantage of negative gearing is that you can offset the loss from owning a property with the income you earn from it. This will eventually decrease the taxable income and your tax liability will decrease. Those who pay high tax may prefer negative gearing when it comes to investing in real estate, as it will increase their tax return and also allow long term capital growth.
The downside of negative gearing is:
- ⛔️ Tax benefits largely help higher income earners, if you aren’t paying any tax then there is no point in getting a discount on it!
- ⛔️ It can inflate property values making it harder to get into the market if you are a first home owner.
- ⛔️ Depending on how negatively geared you are, you could be entirely reliant on capital gains and get into issues if expenses significantly increased.
Negative Gearing – Is it an option for those who are well-off only?
Data from the ATO has found that around 69 per cent of people who claim negative gearing have a taxable income below $80,000. Although a large number of taxpayers claim net rent losses, it only represents around 10 per cent of people with taxable income.
On the contrary, more than 56 per cent of people who claimed negative gearing benefits earned less than $80,000 taxable income, before negative gearing reduced their income.
What is an example of Negative Gearing?
Time to go through a worked example of how a property investor’s figures look with Negative Gearing.
Jack a real estate investor purchased a brand new three bedroom unit in Brisbane’s CBD for $500,000, which can be rented for $400 per week.
To avoid lenders mortgage insurance Jack puts in a 20% deposit of $100,000 meaning he has a loan of $400,000 with interest-only repayments at 4.50%.
|Annual Income||Annual Expenses|
|Rent||$20,800||Loan at 4.50%||$18,000|
|Body Corp Fees||$4,000|
|Total Income||$20,800||Total Expenses||$37,500|
|Total Income / Loss||-$16,700|
So based on his investment, Jack would have recorded a taxable loss of $16,500 which he’ll be able to negatively gear or offset against his current taxable income.
|Individual Taxable Income||Expenses|
|PAYG Salary||$110,000||Property expenses||$37,500|
|Rental Income||$20,800||Other deducations||$1,000|
|Total Income||$130,800||Total Expenses||$38,500|
|New taxable income||$92,300|
Based on Jack’s original salary of $110,000 he would have paid $29,762 in total taxes, but with the losses of his negatively geared property in Brisbane his taxable income would be reduced to $92,300 and total taxes are reduced to $22,999.
Jack would possibly receive a tax refund of $6,763 which can be used towards paying down his home loan, or even as a deposit towards another property.
The best part is that depreciation is not a hard cost, in other words, you aren’t physically shelling out $12,000 per year in wear and tear expenses.
What Types of Properties are Positively Geared?
There are lots of positively yielding suburbs around Queensland, but first, let’s look head to head between a negatively and positively geared property.
As you can see from the case study below, understanding the right investment property for you really comes down to a few factors:
- ✅ Your Taxable Income
- ✅ Property Purchase Price
- ✅ Property rental income
- ✅ Property expenses, including interest rate
But there are still lots of positively geared properties around…
The downside is that they can come at a risk, they are sometimes regionally based as is the case with the list below, so selling the property when you are done could take longer.
|Suburb||Property||Median Price||12 Month Growth||Weekly median advertised Rent||Gross rental Yield|
|🏠 Charters Towers City||House||$115,000||-8%||$240||11%|
|🏠 North Mackay||Unit||$123,750||-29%||$223||9%|
|🏠 East Innisfail||House||$165,000||0%||$295||9%|
Changes to Negative Gearing
In 2019 we will have a federal election, with the Australian Labor Party looking to make changes to Negative Gearing and Capital Gains Tax if they are elected.
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 buyers 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.