Negatively-geared Property Investments

Learn how negative-gearing can work when investing in property.

Tax-effective investment properties

Negatively-geared investment properties have been attractive to investors in Australia for many years due to the tax concessions on offer and the excellent performance of the property market. But many clients still ask me to explain exactly what negative-gearing is.

What is negative-gearing?

Gearing is simply another word for borrowing to invest. Negative gearing is when the resultant borrowing interest and investment running costs exceeds the investment income. So with an investment property this happens when mortgage interest and other costs are more than the rental income earned.

How does it work?

• You borrow funds to buy the investment property.
• The property is rented out to a tenant.
• You keep track of all deductible expenses like council rates, repairs, insurance, advertising for tenant, property manager’s fees (if managed by a real estate property manager)
• At the end of the year the rental loss (rental income less interest and other costs) is offset against other taxable income saving you tax.

Let’s look at an example

Say you have taxable income of $125,000 per annum and buy a property for $450,000 and rent it out for $500 per week. Assuming your mortgage interest is $32,000 p.a. and other costs add up to $5,500 then your rental loss for the year would be $11,500.

Your taxable income is calculated as follows:

So, the investment cost $11,500 but your Net income only dropped by $6,958. Tax savings of $4,542 were achieved. The Govt has subsidised your investment to the tune of $4,542.

But it gets even better when depreciation is included

Depreciation and the capital building allowance is the write-down of the fittings and construction cost of the property. For purposes of our example, let’s say for the first year the depreciation is $2,500 and the building allowance is $5,000. These amounts are allowed as annual deductions thereby increasing the rental loss. But, they are non-cash items as you don’t physically pay them like you do the interest or the council rates.

Let’s see what tax situation is with depreciation included:

Now the tax saving is $7,505. The difference in net income is $11,495 but the depreciation and building allowances can be added back as they are non-cash items. Difference is only $3,995. This means that it cost $3,995 out of your pocket after Govt chipped in $7,505 in tax savings.

Wealth creation – how it works

 Assuming property market is increasing by a modest 5% on average then the property bought for $450,000 would increase to $472,500 over the year. In our example it cost $3,995 to fund the investment. Even after capital gains tax at top rate of tax the increase in net wealth as a result of the growth in the property value would be $17,265 surpassing the cost of $3,995 by $13,270. This is the net increase in wealth.  Even if only 2% growth was achieved the net wealth would have increased by $2,910.

Why it works

The reason this strategy is so effective is because you are using the bank’s money and the tax benefits (negative gearing and depreciation deductions) to increase your wealth.

This is amplified in this example but depending on the age of the property and the rental yield the net result can be very different. That is why it is extremely important that you get appropriate advice before embarking on an investment of this type.

Attention to detail can make all the difference between an investment that effectively grows your net wealth and an investment that drains you of disposable income and ends up costing you money.

That is why I encourage you to contact Antree for an analysis of the tax-effectiveness of an investment upfront. We have associations with financial and mortgage consultants who we know and trust who can assist you in setting up your investment appropriately.

Disclaimer

These investments are not suitable for everyone and depending on your marginal rate of tax the illustrated tax benefits will vary. Before you invest in something costing hundreds of thousands of Dollars it makes sense to spend a few hundred Dollars on due diligence to make sure the investment and the borrowing structure is optimized for the best results.