Negative Gearing & Property

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Negative Gearing by definition is where you borrow to acquire an asset and the interest and other tax deductible costs you incur exceed the income you receive from the investment.

While Negative Gearing is commonly associated with rental properties, it can also be applied to other types of income-producing investments such as shares and managed funds. In terms of property investment, negative gearing refers to the situation where your expenses to maintain the property (including mortgage interest) exceed the rental income.

Creating wealth through purchasing an investment property is a well established practice in this country. The attraction of borrowing or gearing to invest is that it enables you to invest in shares or property that might otherwise have been unaffordable. For individuals, the loss can also be offset against other assessable income and the tax benefit will depend on your marginal tax rate.

Make no mistake, negative gearing can be a risky business because while gearing can amplify your gains, it can also magnify your losses. If you negatively gear property, you need to understand some important points:

• Properties are expected to generate profits only through capital gains and the gains need to be greater than the total losses incurred over the course of the holding period. Of course, there is no guarantee that the value of the property will appreciate, or at least appreciate enough to cover your losses.
• Investing in property requires planning and extra caution must be exercised when a property is projected to generate a negative cash flow. Tax benefits should not be the only reason for the property purchase.
• For taxation purposes, depreciation on the building could be tax deductible, however, the depreciation also reduces the ‘cost base’ of the property. The greater the depreciation you apply on your property, the lower the cost base value which may result in a larger taxable capital gain on sale.
• 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.  Negative Gearing implies a negative cashflow that you need to fund from other sources.
• You have to remember that the family home is a purchase from the heart while an investment property needs to be a purchase from the head.                     

Read More - Negative Gearing Traps Exposed

CASE STUDY

Let’s assume you buy a flat for $600,000 in your personal name and borrow $400,000 (a conservative 67% LVR) to fund the purchase. The funds are borrowed at an interest rate of 5.5% and the weekly rent is $600 or $31,200 a year. Ongoing costs including agent’s fees, rates, insurance, repairs and maintenance and other expenses are summarised below:

Sample Profit & Loss Statement on the Property

Rental Income - 52 Weeks @ $600 LESS : Expenses Interest $400,000 @ 5.5% Water Rates Council Rates Insurance Repairs & Maintenance Agents Fees - 7% of Rental Income Bank Charges Body Corporate Fees Net Tax Loss (before Depreciation) Less: Depreciation (based on Depreciation report) Net Tax Loss

$22,000 $1,086 $1,450 $1,200 $1,500 $2,184 $80 $2,500 ---------

$ 31,200 $32,000 ---------- $800 $4,400 $5,200

So, although the Gross yield is a healthy 5.2% , after annual interest repayments and all associated expenses you have actually ‘lost’ $5,200 during the year, although the actual 'cash' outgoings are limited to $800 as depreciation is a non-cash deduction.

In this example, you will reduce your taxable income by $5,200 through incurring a loss on the investment property. If you had a taxable income greater than $180,000 in the 2024/2025 financial year you would be on the highest marginal tax rate of 47% (including the Medicare levy) and this tax deduction would have the ultimate effect of reducing the after tax 'cash' cost of the property from $800 to a net annual positive 'cash' income $1,956 or $38 per week. The tax treatment has turned a cash outlay into a positive cash flow. If you are on a lower marginal tax rate of tax of 34.5%,  the annual cash cost on the investment would be reduced from $800 to a positive cash income of $994 (or $19 per week). 

Keep Excellent Records for Your Investment Property.

As accountants, we are committed to helping clients simplify their record keeping and aim to minimize tax return preparation costs. If you own an investment property we recommend Rent Manager to keep all your rental property tax records in one place.

Historically we have found the calculation of capital gains on the sale of property to be a source of major headaches and frustration due to the loss of source documents. Rent Manager keeps your purchase and sale records for capital gains tax purposes plus all the information you need to prepare your annual tax returns. It also allows you to analyse potential investment property purchases through the ‘property analysis’ module.
 
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