As you might guess, negative gearing is the opposite of positive gearing where rental income received from the property is less than the sum of outgoing costs. So why would an investor choose to seemingly lose money?
Advantages of Negative Gearing
Reduce taxable income
When a property is negatively geared, the shortfall can be claimed as a loss when doing your tax return. By reducing your taxable income you can reduce the amount of tax payable. Many investors choose to negatively gear their investment for this purpose, with the aim of achieving strong capital gains over time.
Focus on capital growth
Investors who choose negative gearing are typically targeting long term capital growth above their accumulated losses for when the property is sold. This means that in the short term, negatively geared investors are able to save on tax whilst benefiting from long-term capital growth.
Lower Interest Rates
Interest rates are currently at a historic low in Australia, making negative gearing a popular option for many investors as many properties are now only incurring a small loss, making it easier to hold onto an asset.
Points to note:
Maintain a buffer
A high income or cash reserve is often needed to maintain a negatively geared investment strategy to ensure you’re able to hold the property long enough to achieve the targeted capital growth.
Since a negatively geared property investment is not generating positive cashflow, this may make it harder to build on your existing portfolio.
Growth location/quality property
It’s always important to choose a great location and a quality property with strong long-term potential – more so with a negatively geared property where you are targeting long term price growth.
The conversation around gearing tends to go hand in hand with tax or tax benefits – as a tax saving or tax increase can impact your cashflow over the year.
Owners of investment properties are eligible to claim tax deductions for a number of expenses involved in holding a property. Most investors are aware of some of the deductions they are entitled to claim such as their property manager’s fees, council rates and any repairs and maintenance costs.
However, often investors are unaware of property depreciation, which for new properties, in particular, can have a big impact on cashflow – and whether a property has positive or negative cashflow.
Over time, any building and the assets contained within it will experience wear and tear. Legislation allows investors to claim this wear and tear as a tax deduction called depreciation.
But unlike other expenses involved in holding a property, such as repairs and maintenance for instance, an investor does not need to spend any money to be eligible to claim it.
For this reason, depreciation is often described as a ‘non-cash deduction’. I.e. it’s not an out-of-pocket cost, but you can still claim it as a deduction.
Many investors choose to purchase new properties to take advantage of the higher depreciation claimable compared to older (second-hand) properties with low or no depreciation to claim.
What equipment qualifies for depreciation?
Common items that qualify for depreciation includes:
- The building’s structure
- Dishwasher & washing machines
- Carpet & timber flooring
- Exhaust & ceiling fans
- Microwaves & ovens
- Smoke alarms & air conditioning
- Cooktop & furniture
How to obtain a depreciation report?
A depreciation report is provided by a Quantity Surveyor – this report will outline all the deductions an investor can claim for any specific property at the end of each financial year. Your accountant will then use the figures outlined in the depreciation schedule when submitting the investor’s individual income tax return at the end of financial year.
A common misconception with many investors is the idea that a negatively geared investment property always means negative cashflow. But the following, simple example, illustrates that this isn’t always the case – as depreciation can have a significant impact on cashflow for new properties.
Last year, John bought an investment property – a new apartment – for $600,000 earning a rental income of $600/week. He paid a 20% deposit of $120,000 and has an interest only loan of 5.5%.
At the same time, Anna bought an investment property – a second-hand apartment – for $600,000 earning a rental income of $650/week. She also paid a 20% deposit of $120,000 at the same interest rate of 5.5%.
This article is intended to provide general information only, current at the time of first publication. It does not constitute any financial advice, offer, contract or inducement to buy. Investors are expressly recommended to do their own due diligence in relation to any investment decision they make and seek independent financial advice.