What is negative gearing?
Negative gearing is when the costs of owning an investment property (such as interest on the loan, bank charges, maintenance, repairs and capital depreciation) exceed the income it produces.
With financial and tax advice, and the right property, negative gearing may be a tax efficient investment strategy. This may be an option if you're thinking about entering the property investment market for the first time or want to increase your investment portfolio.
An example of negative gearing:
If your expenses for an investment property (interest, maintenance, council rates etc.) are $2,600 a month
But your rental income on that investment property is only $2,000 a month
Your shortfall would be $2,600 - $2,000 = $600 a month (or $7,200 a year), leaving you negatively geared. You may be able to offset this loss against other income, depending on your circumstances.disclaimer
Negative gearing, when combined with a long-term profit outlook, could create wealth to help you achieve your financial goals sooner.
What kind of deductions can I claim from my investment property?
If you own an investment property, you may be entitled to claim tax deductions and depreciation against your rental income from that property. Examples of expenses you can claim are:
- Interest on the loan, ongoing maintenance expenses, property management fees, council rates, body corporate fees, landlord insurance.
- Tax depreciation on applicances used in the rental property, such as a hot water service and white goods (e.g. refrigerator and oven). Depreciation schedules are set by the Commissioner of Taxation and range from a few years to over 20 years.
- Building allowances - you may also be entitled to claim depreciation of capital works, specifically for the building.
Does negative gearing have any risks?
There is usually an inherent risk associated with borrowing to pay for an investment. While negative gearing can help you increase your gain on borrowed funds, the losses can be large in adverse circumstances.
As a general rule, only investors who have the financial capacity to absorb the effect of potential falls in investment values, as well as an increased cost in interest payments, should consider negative gearing.
You may be able to minimise the risk of negative gearing by:
- choosing your investment property carefully. It may be worth trying to find a property that's likely to increase in value throughout the investment period.
- having a sufficient income to cover the interest repayments in case your tenants are late with their rental payments, or if your property remains vacant for any time. You also need to be able to pay for ongoing repairs and maintenance.
- taking out mortgage protection insurance with your investment loan, and landlord insurance for the property.
What about positive gearing?
Your investment is positively geared when the income from that investment exceeds your interest expenses, as well as any other possible deductions.
Do bear in mind that you may be need to pay tax on any income you get from a positively geared investment.
Which investment strategy would suit me?
You should speak to your financial adviser and registered tax agent before putting any investment strategy into action, whether you're looking at positive or negative gearing.