Negative Gearing FAQ
Negative gearing is term used to describe an investment where costs associated with the investment asset outweigh income from the asset, thus allowing you to achieve a tax benefit. Effectively you are making a short term loss to hopefully achieve a significant capital growth in the asset.
Negative gearing occurs when you borrow a majority of the property value. The interest rates and other property expenses are deductable providing tax benefits. That is, the loss on the property can be offset against any other income.
The immediate tax benefits of Negative gearing help assist investors into the market and allow investors to purchase properties with a higher value using borrowed funds.
How does it work?
Let’s see an example of how Negative gearing works...
John and Sue are property investors and purchase a unit for $400,000, putting down $80,000 as a deposit (using a line of Equity from their current home) and borrowing the remaining $320,000. The additional costs associated with the purchase of the property such as stamp duty were paid for from their cash savings. Let’s assume that they organised a fixed interest loan at an interest rate of 7%, which equates to $28,000 of interest payable each year. As they have purchased an investment property with high rental demand, they are also achieving good rental return which provides them with rental income of $20,000 per year or $385 per week.
With any investment property, there will also be ongoing costs which the landlord (Investor) will have to pay. These costs can include Property Management Fees ($1,400), Body Corporate Fees ($1,500), Council Rates ($1,000), Water Rates ($400), Insurance ($400) and Maintenance ($300).
As the investors have purchased a new unit, they are also allowed to claim depreciation of the building as well as the fixtures and fittings. This value could amount to $10,000 in the first year for this example.
So the investor has made $20,000 in rental income, however has paid out $33,000. We take into consideration the depreciation as a deduction and the investor has lost $3000 ($20,000 – ($33,000-$10,000) = $3,000). This loss can thus be offset against the investor’s salary.
If Sue was the primary income earner on $80,000 per year, then they would only be taxed on $77,000, producing an after tax effect of $1,755. The property would only need to increase by $3,000 for them to be better off. It is likely that a well selected investment property may grow at 7% + a year which would have provided them with $28,000 in equity, less the $3000 invested, providing them with a $25,000 gain!