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How Does Negative Gearing work?
You’ve probably heard the term ‘negative gearing’ before, but what does it actually mean?
Here’s a simple explanation of how negative gearing works, what the potential tax benefits are, and what to watch out for.
What is negative gearing?
Negative gearing was introduced in 1936 in an attempt to stimulate the Australian economy after the Great Depression.
In a nutshell, negative gearing is when the costs of owning an investment property – for example, your mortgage interest, strata fees and maintenance expenses – exceed the income you get from renting it out.
What are the benefits of negative gearing?
If you’re considering investing in a property where the rental income would be less than your mortgage repayments, it’s important to review the pros and cons.
An investor could potentially benefit from negative gearing through:
- Capital gains. The short-term losses of negative gearing may be outweighed by the long-term returns, especially if housing prices are set to rise or if you can add value to a property through improvements or renovations. Remember, capital gains tax will apply to any profit you make on the sale of an investment property – although there are ways you may be able to avoid it.
- Reducing your tax liability. Depending on your marginal tax rate, you may be able to offset the losses from a negatively geared property against your income, including your wages and positive cash flow investments. However, this should not be your sole reason for buying a property. It’s also important to note that there may still be a loss in after-tax income on your negatively geared property.
On the other hand, it’s important to take into account the:
- Greater responsibility. If your financial circumstances change for any reason, you’ll still need to keep making payments on your mortgage, maintenance and other expenses.
- Potential higher cost. You may need to have a lot of upfront capital when buying an investment property to account for the running costs of maintaining an investment property.
To give you an example of the potential long-term gains of a negatively geared property, let’s say you decide to purchase a $460,000 apartment unit near the CBD of a major city, where prices have been steadily climbing over the past few years. You put down $50,000 for the deposit and take out a $410,000, 30-year home loan, with the interest rate fixed at 5% for the first three years.
In the first 12 months, the interest on your mortgage is just over $20,000, and other costs associated with owning the property come to $3,400. That’s a grand total of $23,400 in expenses for the first year. Meanwhile, the property brings in $380 a week in rent, making an annual income of $19,760.
So, in this example, the property is negatively geared to the tune of $3,640.
As always, it’s important to consider your personal situation, income and any tax implications before buying an investment property. Be sure to consult with your financial adviser to determine the right investment plan for your particular situation.
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