April 22, 2016
What is Negative Gearing?
Many property investors make use of “negative gearing” but what is it? Negative gearing occurs when an investor uses borrowed funds to acquire a property. If the costs of owning and managing this property (including interest but excluding principal repayments) exceed the gross income (rent) derived from it, then the property is said to be “negatively geared”.
How Does Negative Gearing Affect Tax?
The Australian tax system allows losses made under a negative gearing position to be offset against other income, such as salary. This means that the net loss from the property is lowered by reducing the owner’s tax bill. This benefit can be magnified when depreciation of fixtures (such as an air-conditioning) can be included in the profit & loss calculation for the property (depreciation is a non-cash item, so does not affect an investor’s cash flow).
Why is this Attractive to Investors?
Property investors who are negatively geared are usually hoping to make a profit over the medium- to long-term through capital appreciation. They will often borrow a large percentage of their investment funds (this is called being “highly geared”). If the property does rise in value, the return on their own cash investment can be high. Also, over the medium-term, investors hope that rents will rise to become bigger than their costs, making the property “positively geared”.
What are the Risks?
Negatively geared properties make a loss. Even allowing for the tax deductions, investors must still be able to manage to cover these losses. In addition, highly geared investors are very vulnerable if prices go down. With limited equity in the property (at least initially), even small declines in house prices can wipe-out the initial investment. Older homeowners will remember the early 1990s, when many homeowners had negative equity in their properties.
Who Should I Speak to About Negatively Gearing
It is essential to receive proper advice from a qualified financial planner prior to making any investment decisions.