Put simply, negative gearing occurs when an investor borrows money to buy a property, and the cost of owning and running that property exceeds the rental income it generates. As an investor of a negatively geared property, you make up the gap between the expenses on the property and the rental income. This isn’t always easy but there are some negative gearing tax benefits.
What is the difference between negative gearing and positive gearing?
There are clear differences between a negatively geared property and a positively geared property, so before we go any further, let’s take a quick look at them:
- The cost of owning and maintaining the property, such as mortgage interest, management and maintenance expenses, exceed the rental income.
- The property needs a regular cash top up to cover the difference between the expenses and the income it generates
- The losses on the property can be deducted from your taxable income, which can potentially reduce your tax liability.
- Negative gearing is generally used as a ‘long-term’ strategy to build wealth.
- A negatively geared property relies on the future growth in the property’s value so that current losses are offset.
- The rental income is higher than the total cost of owning and maintaining the property.
- You need to pay tax on the income you make above the expenses of the property.
- Additional income can be reinvested or used to offset other investment costs.
- A positively geared property brings in a regular income so provides shorter-term financial gains.
- This strategy does not rely on the appreciation of the property the gains are earned straight away.
What are negative gearing tax benefits?
Although the costs of keeping a negatively geared investment property running can quickly mount up for an investor, there is a silver lining. The property’s losses are deducted from an investor’s taxable income.
Eg. If Geoff’s taxable income is $85,000 and his investment property losses equal $10,000, his taxable income is $75,000.
How does negative gearing reduce tax?
When a property is negatively geared, an investor’s overall tax bill is reduced. For some investors, there can be a healthy tax refund at the end of the year. For higher income earners, these investment costs, can also help them to offset some of their other income. In some cases, this can even move them down a tax bracket
Read more about investment properties and tax deductions for property investors over on our Property Investment Tax Hub
Negative gearing calculator
Negative gearing isn’t always a chosen strategy, interest rates and other expenses can increase considerably faster than the increase in rents. This leaves a lot of investors, particularly vulnerable to finding themselves topping up the investment bills. If you’re not sure whether your property is negatively geared, check out this negative gearing calculator from ‘Your Mortgage’.
The downsides of a negative gearing tax strategy
Negative gearing a property can be risky as Government policies can change what expenses you can and can’t claim without warning. With interest rates and the cost of living increasing, it’s also not always possible to ‘carry’ the top up expenses of an investment property for long periods. This is especially the case for the majority of property investors, who typically invest in perhaps one or two properties to help with financing their retirement.
According to Property Update: 71.48% of investors hold 1 investment property. 18.86% of investors hold 2 investment properties. 5.81% of investors own 3 investment properties.
Negative gearing can bring considerable risk. It relies on the fact that the value of the property increases as expected, and in the timeframe required. If the property’s value doesn’t rise and the rental prices don’t catch up with expenses, the property continues to be a burden on the investor’s finances. It also won’t reap the rewards needed at the point of selling, or when the investor reaches retirement age.
Will there be an end to negative gearing?
In recent years there has been a lot of talk about stopping the tax benefits of negative gearing all together. The main arguments being
- it drives up house prices because it fuels demand for investment properties which, in turn, makes it harder for first time buyers to get into the market.
- negative gearing benefits wealthier people who invest in multiple properties to take advantage of the ability to lower their taxable income and pay less tax.
However, the debate goes on as the negative gearing tax benefits help many young investors to get into the market, and others to buffer their retirement income.
3 Tips for owning a negative geared property:
Review you finances regularly
Keep a close eye on your financial situation. Regularly review your income, expenses, and cash flow to ensure you can comfortably cover any shortfalls. It’s crucial for investors to have a financial buffer to manage periods where income falls short of expenses, as well as unexpected maintenance costs, or periods of vacancy.
Property market research
Keep up to date with the property market in the area around you property and the broader economic trends. Staying across market conditions can help you anticipate changes in rental income and property values. This knowledge is vitally important for making informed decisions about when to buy, sell, or adjust your investment strategy.
Seek professional advice
Talk to professionals throughout your investment years. Financial advisors, accountants, and property experts who have experience in negative gearing can help you navigate the complexities of property investment. They can also provide valuable information for negative gearing tax strategies.
Need tax advice and guidance for your annual tax returns? Get in touch with Etax. Our friendly accountants make sure your negatively geared property tax deductions are all accounted for on your annual tax returns.
In conclusion, while negative gearing can offer financial advantages long term, it’s essential that investors are fully aware of the potential challenges and be prepared and able to take steps to mitigate risks. Regular cash flow reviews, staying up to date with the market and using a tax agent will give you the best chance of reaping the rewards of a negatively geared property.