With all this talk around Labor's proposed changes to negative gearing popping up in the media at the moment, you may have a few questions around negative gearing and what it actually is.
In the first instance, let's take a quick look at what gearing – positively or negatively – actually means on an investment property.
Basically, when a property is positively geared the annual rental income received from the property is higher than the annual loan repayments and costs.
Negative gearing on the other hand, occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income, like your salary, to provide tax savings.
Say for example you have an investment property that collects $200 a week in rent, but your mortgage repayments are $300 a week, meaning you are making a loss of $100 a week or $5,200 a year. This negative cash flow will be taken into account when the government assesses your taxable income. In this example, an annual income of $90,000, would be taxed as though your actual income was $84,800 ($90,000 - $5,200 in losses).
If you know in advance that your investment will record a loss over the financial year, you can apply to the Tax Office to reduce the amount of tax taken out of your salary each pay cycle. This is called PAYG Withholding Variation and it can provide a real boost to your personal cash flow. Speak to your tax advisor or accountant for more details.
When put like this, it is easy to see why negative gearing could be considered an attractive option for many investors.
One of the most common misconceptions associated with negative gearing is that it serves one purpose – to help wealthy investors become even wealthier. This is simply not the case.
In the past, negative gearing has provided first time buyers and mum and dad investors with an incentive to invest in property by way of various tax concessions. Ultimately, negative gearing makes a positive contribution to the supply of affordable housing in Australia – something we are in short supply of.
Before making any decisions that will impact your property investment plans, it is important to consult with a professional. Contact your local Mortgage Choice home loan expert today.