Negative Gearing: How It Works
Whether you choose to call it an investment tool or a tax strategy, there is little room for debate as to the popularity of negative gearing. For those people who are interested in owning investment real estate such as rentals and could also benefit from a solid tax shelter, it appears to be an ideal solution. In this article, we will explore exactly how negative gearing works as well as the ups and downs of this somewhat controversial approach to financing.
Negative gearing is a financial strategy where a person borrows money to purchase an investment property that he or she fully anticipates will lose money; at least for the near foreseeable future. This fundamentally means that the cost of owning and operating the property will exceed the amount of income (rent) that it generates. As soon as the rent collected from the property is either equal to or exceeds the total operating costs of the property, the investment is now positively geared.
It is perhaps at this point that you may be asking yourself, “Why would I borrow money to invest in a property that I know is going to be a loss?” That is a great question, and the answer lies within the Australian Taxation Office.
You see, if the costs associated with the loan are in excess of the property’s rental income, the Australian Taxation Office will allow the investor to claim the lost money against their own personal income. Deductions. This in turn reduces the investor’s overall tax burden and results in a positive financial position. In other words, the money saved through the deductions offset the losses incurred with the investment property.
Now before you think that this is where the benefits end, consider something this additional point. You still own the property. That means that if the value of the house or rental should increase, you are rewarded from the capital growth the property experienced. This is the second way in which a negatively geared property investment makes sense for some investors. Furthermore, keep in mind the following.
- Only 50% of the capital gain is taxable if you maintain ownership for more than a year.
- Ownership transfer can be strategically timed for maximum tax year benefit.
- You can deduct your losses in the same financial year. Tax benefits are immediate.
- Property fixtures and fittings are seen as plant. Depending on the calculated life, a depreciation deduction is allowed.
- You may deduct the cost of various maintenance and repair costs.
Compare this to owner-occupied real estate and one glaring difference is evident. Expenses incurred with owner occupied property that are related to mortgage interest, property improvements, repairs, and upkeep are NOT deductible.
Possible Negatives? Maybe. Some experts within the financial industry will claim that this is an outdated financial strategy and that the capital growth for Australian real estate is not keeping pace with the potential for losses that could be incurred. They argue that it is far sounder to pay taxes on profits than to construct losses.
In addition to the financial perks to the investor, many advocates purport the social benefits of these programs as well, stating that the tax deductions are encouraging investments in rental properties that may otherwise be left abandoned. Ownership and improvements on this real estate elevate neighborhoods and provides affordable housing to individuals and families who may otherwise not be able to afford it.
The debate over negative gearing is likely to continue, as is its use as a financial investment tool. Whether or not it is right for any one particular investor is a decision only they and their professional advisor can soundly make.