The real benefits of negative gearing are only realized when you combine the correct tax and financial advice with a property in the right location funded by the most suitable loan product. You should always seek expert professional advice to make sure the purchase is within your budget and will provide long term taxation and financial benefits.
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By definition, negative gearing is where you borrow to acquire an income producing asset and the interest and other tax deductible costs you incur exceed the income you receive from the investment. Creating wealth through purchasing an investment property is a well established practice in this country, however, negative gearing can also apply to other types of income producing investments such as shares and managed funds.
The attraction of borrowing or ‘gearing' is that you can invest in shares or property that might otherwise have been unaffordable. For individuals, the loss can also be offset against other assessable income and the tax benefit will depend on your marginal tax rate.
While gearing can amplify your gains, it can also magnify your losses. For example, it is estimated that the 2008 US sub-prime lending crisis left close to 30% of mortgagees with a loan balance higher than the value of their property.
If you negatively gear property, you need to understand some important points:
Negative Gearing isn't suitable for all investors and the tax benefits should not be the only reason for the property purchase. Although it can lower your tax liability, the tax implications will depend on your personal situation and the type of investment you choose. Negative Gearing implies a negative cashflow that you need to fund from other sources.
Negative gearing of a rental property can be complex. For example, some expenses are not deductible (stamp duty, initial repairs etc.) while other expenses such as borrowing costs and depreciation are generally claimed over a number of years. As such, the right taxation advice can nearly be as important as finding the right property.
To broadly illustrate how negative gearing works let's assume you buy a flat or unit for $400,000 in your personal name and borrow $350,000 to fund the purchase. The funds are borrowed at an interest rate of 8% and the weekly rent is $450 or $23,400 a year. Ongoing costs including agent's fees at 7% of the rent, rates, insurance, repairs and maintenance and other expenses are summarised below:
|Rental Income - 52 Weeks @ $450
- Interest - $350,000 @ 8%
- Water Rates
- Repairs & Maintenance
- Agents Commission - 7% of $23,400
- Bank Charges
- Body Corporate Fees
This relatively simple example suggests, after expenses the net income for the year will be $17,000 ($23,400 minus $6,400), equivalent to a net rental yield of 4.25%. However, annual interest repayments are $28,000, so the tax deductible loss is $11,000 for the year ($23,400 minus $34,400 = -$11,000).
Assuming you own the property in your own name, the loss will reduce your taxable income by $11,000 and if you had a taxable income greater than $180,000 in the 2012 financial year, the after tax cost of owning the property would only be $5,885 or $113.17 per week (based on a marginal tax rate of 46.5%). If you were on a lower marginal rate of tax of say 31.5% (including Medicare levy) the after tax cost would be $7,535 (or $144.90 per week).
When buying an investment property we can assist you in several areas:
Contact us today on (03) 8685 8300 to discuss how we can help you with your wealth creation and investment strategies including gearing an investment property.