In its simplest form, our understanding of negative gearing is that it involves setting up an investment property to make a net loss in any financial year, when you look at the income and expenses associated with that property.
Why would anyone in their right mind deliberately make a loss? You wouldn't deliberately run a business at a loss, would you? And you certainly wouldn't pay a lot of money for a business that's already making a loss, right? So why buy a property that's making a loss?
To answer that, we hand over to our trusty accountant, Rhett Hollick at AMHR.
"When you make a loss on an investment property in a particular financial year, the Australian Tax Office (ATO) allows this to offset or reduce your other income that you need to pay tax on" says Rhett.
"So, if for example you're in the 47% personal income tax bracket and your property makes a loss of $10,000, then you'll pay $4,700 less tax than if you didn't own the property.
In other words, if you make a $10,000 loss in the above scenario, you've really only made a $5,300 loss once the tax deduction is factored in."
Why would you deliberately buy something that is still going to lose you $5,300?
"Well rent isn’t the only income that a property generates. It also can hopefully go up in value. The tax consequences of being able to negatively gear means that the property doesn’t need to go up in value by as much in order for it to be a profitable overall investment."
Of course, this is only scratching the surface, and Rhett reminded us that you have to pay capital gains tax when you sell your investment for a profit. He reinforced that everyone should seek their own tax advice in relation to how negative gearing would work in their specific circumstances.
If you would like further information on negative gearing, then give Rhett and the AMHR Team a call on 9362 5100. They are our go-to people regarding these matters, and have helped us with previous blog posts, including this one on Offset Accounts and this one on Tax Depreciation Schedules.
Here are some other informative blogs you may be interested in checking out:
First Home Owner Grant changes - how do they affect me?
Buy where you can afford, rent where you want to live...
How do I calculate my home loan repayment?
How is a mortgage broker paid?