Property investing and negative gearing go hand in hand for some people
Gearing 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.
Why invest in something that makes losses year after year? Two reasons. First, a well-located property can rise in value over time, producing a capital gain. Second, the annual loss can usually be offset against other income including salary or wages.
Let’s say your annual salary is $80,000 and your investment property makes a $20,000 loss for the year. In this case you only pay tax on income of $60,000 — not $80,000.
But negative gearing is not a magic formula for growing wealth. Be aware of the potential pitfalls to make the most of negative gearing.
The idea of saving on tax can be appealing. But it’s wise to consider it within a broader investment strategy. Will any losses be compensated by future capital gains? For this to happen your property needs to rise in value by more than your out-of-pocket expenses plus any potential capital gains tax.
There are no guarantees when it comes to capital growth. Australian property prices have generally risen over time. But the market moves in cycles over shorter periods. So, you could make a loss if you sell in a soft market.
Your investment makes an annual loss if it is negatively geared. You can lower the tax you pay on other income by claiming this loss as a tax deduction. 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. You may also need to ensure your cash flow can cover costs if the property is vacant for periods of time.
Negative gearing is not a guaranteed money-making strategy. It can help you save on tax and make owning a rental property more affordable. But it’s not the only option.
It’s possible to invest in a positively geared property where the rent outweighs the costs of owning the investment. This adds to your income rather than reduces it. If that sounds attractive you may need to find the right property for your investment situation.
Speak to a tax professional and accountant to figure out the right investment strategy for you. For your mortgage needs, talk to an Aussie Broker.