If you’re looking to buy in the near future, it’s important to know what negative gearing is and the benefits it offers, along with possible risks involved.
Gearing is borrowing money for investment purposes and is mostly linked with investment in properties.
There are three types of gearing – positive gearing, neutral gearing, and negative gearing.
- Positive Gearing – When the rental income is more than the interest repayments and other costs, such as renovation work, insurance, rates, etc.
- Neutral Gearing – When the rental income is the same as the interest income and other costs.
- Negative Gearing – If the rental income is less than the interest income and other costs.
Benefits of Negative Gearing
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.
As a result, the burden associated with the cost of owning a property shifts to the following:
- The Australian Tax Office – in the form of tax savings
- Tenants – in the form of rent
- Other surplus cash flow, including other incomes and savings
Negative Gearing – Is it an option for those who are well-off only?
Data from the ATO has found that around 69 percent of people who claim rent have a taxable income below $80,000. Although a large number of taxpayers claim net rent losses, it only represents 13.1 percent of people with taxable income.
On the contrary, more than 25 percent of people who claimed net rent had more than $80,000 taxable income. While a number of people reap benefits from these tax rules, it’s the high-income earners that receive the maximum advantage from negative gearing.
Does Negative Gearing Make It Hard to Afford a Property?
Negative gearing is only one aspect of property and the following factors trigger the rise in property prices:
- The cyclical nature of the real estate market
- A strong reasonable economy
- Low-interest rates
Negative Gearing Leads to Capital Growth
If you buy a property for $500,000, then you get a loan for $450,000 with a 6.5% interest rate. The annual rent payment on that loan will be $29,250. You are also receiving weekly rental return of $500, which sums up the rental income for the year to $26,000.
Based on the example, you are making a loan repayment of $29,500 which is higher than the rental income of $26,000. Therefore, there is a shortfall of $3,500. But at the same time, the value of the property keeps rising as time passes.
Therefore, if the value increases by 15% in one year, there is a total increase of $75,000 in a year. Despite the shortfall of $3,500, you gain an overall increase in value by $71,500.
Therefore, in this case, negative gearing is not a bad thing if the capital growth is more than the rental shortfall.
To summarise, negative gearing only works well if the value you earn from capital growth is more than the loss you suffer from a rental shortfall. However, make sure you include all the expenses related to the property including tax return income.
Chat to our team today about how negative gearing works, call us on 1300 088 065 or email Nathan at Nathan.Vecchio@HunterGalloway.com.au