How to use negative gearing to your advantage
‘Gearing’ simply means borrowing to invest. A property is negatively geared when the costs of owning the place exceed the rent you receive. In other words, you make a loss each year.
But why invest in something that dishes up losses year after year? There are two main reasons. Firstly, a well-located property can rise in value over time, letting you earn a capital gain.
Secondly, the annual loss can usually be offset against other income including salary or wages.
Let’s say for instance that your annual salary is $80,000, and your investment property turns in a loss of $20,000 for the year. In this case, you’d only pay tax on income of $60,000 – not $80,000.
A helping hand from the Tax Office can make it more affordable to invest in a rental property. However, negative gearing is not a magic formula for growing wealth.
To make the most of negative gearing, it’s worth being aware of the potential pitfalls.
Capital growth can be the deal breaker
The idea of saving on tax can be appealing, though it’s wise to consider it amongst a broader investment strategy. Will the losses your property notches up each year be made up for by future capital gains? Just to break even on your property, it needs to rise in value by more than your out-of-pocket expenses plus any potential capital gains tax.
The problem is, there are no guarantees when it comes to capital growth.
Property prices generally rise over the long term but over shorter periods the market moves in cycles. If you need to sell in a soft market there’s a possibility you could make a loss.
Negative gearing only reduces the cost
To be negatively geared, your investment has to make an annual loss. Sure, by claiming this loss as a tax deduction, you can lower the tax you pay on other income. Depending on your tax rate, this may cover up to 45% of your losses – not the full amount. The remainder comes out of your pocket, and you might need that cash flow to cover the costs even if the property is vacant for a short period.
Capital growth is not guaranteed
The bottom line is that negative gearing is a not a guaranteed money-making strategy. While it can help you save on tax and make owning a rental property more affordable, it’s not the only option for investors.
It’s possible to invest in a positively geared property, one where the rent outweighs the costs of owning the investment – and adds to your income rather than reducing it. If that sounds more your style, be prepared to widen your search the find the right property.
Speaking with a tax professional and accountant can help you determine which investment strategy is right for you – and leave the home loan with an Aussie Broker.
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- Chapter One : Things to consider before investing in property
- Chapter Two : Determining where to invest
- Chapter Three : Investment Properties by Dwelling Types
- Chapter Four : Finance for Your Investment Property Purchase
- Chapter Five : How to Invest in Property
- Chapter Six : Adding Value to Your Investment Property
- Chapter Seven : Positive and Negative Gearing
- Chapter Eight : Getting Your loan
- Chapter Nine : Selling your Investment Property