Negative gearing is a form of financial leverage whereby an investor borrows money to acquire an income-producing investment property and expects the gross income generated by the investment, at least in the short term, to be less than the cost of owning and managing the investment, including depreciation and interest charged on the loan excluding capita repayments.
Often in the news, but what is it?
Gearing is the general term for borrowing money to purchase an asset. In this case, that asset is property.
Neutral gearing is where the interest you pay on a loan is equal to the income of the loan investment – so you breakeven. Positive gearing is where the interest you pay on a loan is less than the income of the loan investment – so you make a profit.
Most mentioned is negative gearing, where the interest you pay on a loan is more than the income of the loan investment – so you make a loss.
So how is negative gearing a positive?
Basically, negative gearing works best if the money you make from the capital growth of your investment property is greater than the loss you make on the rent in the short term.
For example, if you purchased a property for $550,000 and took out a $500,000 loan at 7% interest to do so. The annual interest rate would be $35,000. If the property is rented out for $540 a week, for an annual rental income of $28,080.
In this situation, you are paying $35,000 on the property every year while making just $28,080, taking a $6,920 loss. However, at the same time, your property should also be increasing in value. If it went up by 10% that year, your investment has increased in value by $55,000. So by the end of the year, you have paid $6,920 in interest, but with the increase in value, you are still $48,080 up on the previous year.
Also, by having the property rented, you are eligible to claim certain deductions on your property too, although there have been significant changes to these deductions in the 2017-18 Federal Budget. Some expenses you can claim deductions for include:
- Advertising for tenants;
- Property insurance;
- Capital items for the property; and
- Real estate management fees.
As with all tax deductions, you must have official documentation and receipts for all expenses related to your investment. You will also require an accurately kept depreciation and capital works schedule.
As with most investments, it’s best to have a financial or tax adviser on your side before making the decision. Whether you are considering gearing an investment property, or already have, our tax specialists at Online Tax Return will work hard for you to maximise your investment. Contact us today for a chat about your tax situation.
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