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- On February 17, 2019
If you are thinking of buying an investment property to create wealth, it is very likely that you would have heard of the term Negative gearing. It is a common practice when it comes to investing in property in Australia. In fact, 1.28mn(Source ATO statistics for 2015-16) or 1 in 10 Australians who file a return is negatively geared in terms of Rental property.
A real estate investment is considered to be negatively geared if the net rental income is less than the interest and other costs.
Before we go into negatively gearing in detail, it is ideal that we understand that what is Gearing? Gearing in simple terms means borrowing money to invest in different income-generating asset class like rental property, Commercial property, shares etc.
It is also a common misconception that negative gearing can only apply to rental properties. This is not the case. You can be negatively geared for investments in shares.
Types of Gearing:
It simply implies that the cost of holding the asset and income generated by it is equal. Neutral gearing has no tax implications.
When the income generated by the investment is greater than the costs of holding the asset, i.e. rental income is more than the outgoings which include interest, rates, insurances, and depreciation, the taxable income generated will be subject to income tax at the marginal tax rate. You won’t be able to reduce the tax you pay on your other income. However, you can use the surplus income to reduce the size of your loan and it can even increase your borrowing capacity. There are other factors also that you should take into account.
An Asset class is negatively geared simply when the cost of holding the asset is more than the income it generates. For example:
John bought an investment property for $500,000 in July 2008. The other costs of acquiring the asset like stamp duty, conveyancing fees etc., were $25,000. His total borrowing for that investment property was $525,000. Since he had enough equity in his permanent place of residence, he borrowed $125k from his home loan and used that as a deposit to buy this investment property and thus he didn’t pay any Lenders mortgage insurance.
Let’s say the rental income from the property is $18,500 a year and the total expenses of holding the asset like the interest costs, rates, insurances, management fees, repairs, Capital works deductions (Capital works such as Building are written off over a certain period), Depreciation (please read the changes section) Land tax etc are $26500. This means that John is losing $8000 a year for holding the property aka he is NEGATIVELY GEARED. You can use this Negative gearing calculator to work out the tax benefit of negative gearing property based on your Taxable income
You have to be mindful that you have to adjust the cost base of the property by the amount of capital works deduction or depreciation claimed over the number of years. For example, in the above example, if John claimed $50k in depreciation and capital works deduction over 10 years, the cost base of the property will be reduced by $50k when working out the capital gains. You can use this capital gains tax calculator to work out the capital gains made on Rental property
How Does It play with Australian Tax?
According to Wikipedia, there are very few countries that allow Negative Gearing.
The losses generated from holding the investment property reduces your taxable income. You claim that as a deduction against your income from other sources like employment income or business income if you are a sole trader
The higher your tax rate and your loss, the greater the benefit will be, i.e. you reduce the total tax paid on your income.
Changes to Residential Rental property deductions
Removal of Negative gearing: As per labour party manifesto, they plan to abolish negative gearing on rental property. However, it will only apply to the established property i.e you can claim it on new properties. The policy will not be retrospective – if you already own property that is negatively geared, you can continue to use this strategy.
Travel Deductions: From 1 July 2017, travel expenses relating to inspecting, maintaining, or collecting rent for a residential rental property cannot be claimed as deductions by investors.
Depreciation: For secondhand residential property purchased after 9th May 2017, you cannot claim depreciation on previously used plant & equipment like Oven, Dishwasher, Rangehood, etc
We have seen above that what is negative gearing and the tax advantage that it offers. However, It is very important NOT to choose an investment property purely on the basis of the tax position. Some of the factors that you should take into account are:
- Expected capital growth
- The timeframe for holding the asset
- Buying in an area of high employment opportunities and low vacancy rates
- Can you afford to keep the property if it is vacant for some time or your income is reduced due to involuntary employment?
General Advice Warning
The information contained on this web site is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs, and where appropriate, seek professional advice.
Taxation, legal and other matters referred to on this website are of a general nature only and are based on our interpretation of laws existing at the time and should not be relied upon in place of appropriate professional advice.
For any tax-related queries, please send us a query using this link.