In Australia, and some other countries, property owners are allowed a tax deduction for losses from negatively geared properties.
It is important to understand what negative gearing is and how it works before setting foot in the world of investment properties. It could mean thousands, or even millions of dollars.
What Is Negative Gearing?
Negative gearing is a property investment strategy where the cost of owning a property is higher than the rental income that it generates each year.
Gearing is financial jargon that means one has borrowed money to buy assets. If rental yield on an investment property isn’t enough to cover the mortgage and interest repayments, those costs will be coming out of the investor’s pocket.
Despite this expense, negative gearing remains a popular property investment strategy. Why?
What are the benefits of negative gearing?
There are some huge benefits for those who choose to negatively gear their investment properties.
Here are the two most important advantages:
1. Tax minimisation
Despite its name, negative gearing has a positive relationship with the investor’s income taxes. Property owners are allowed to deduct rental losses from their taxable income. The rental loss is the total cost of owning the property for the year, minus the rental income. Not only can Australians deduct the rental loss, but also all other related expenses such as maintenance costs and furniture depreciation.
This is a popular method of tax minimisation used by high-income investors.
2. Capital gains
The ultimate reason people are investing in property knowing very well that it will not yield any profits for some years is that they are hoping they will be able to bag a much bigger amount in capital gain when prices rise in the future.
Given the trend of rapidly rising property prices, chances are high that these investors will make a huge profit if they hold onto the property and are able to sell at the appropriate time.
What are the disadvantages of negative gearing?
After learning about the two main advantages of negative gearing, one might want to immediately employ this strategy. However, there are disadvantages:
1. Lower Cash Flow
With negative gearing, some of the expense of ownership comes out of the investor’s pocket.
This reduces cash flow. But there are some tips you can use to manage cash flow when negatively gearing.
2. Capital Losses
A profitable sale is part of a negative gearing strategy but it doesn’t always materialise. There are cases where, even after decades of waiting, the opportunity to sell a property at a profit never comes.
Who Can Benefit From Negative Gearing?
An investor must have certain things in place to benefit from negative gearing:
- A stable source of income: The investor must have a stable source of income other than the investment property, which they can use to finance their mortgage repayments and other expenses.
- Knowledge of property markets and locations: An investor must have adequate knowledge about the property market so that they are able to speculate intelligently on upcoming changes in property prices and invest only in areas where property values are growing.
- High income: The best-case scenario for a negative gearing investor is that they get tax savings from net loss throughout the term of investment property and then gain profit from a sale.
- The ability to bear losses: An investor in a negatively geared property must have the ability to bear losses in huge amounts. Being a high-income property investor helps with this. Having other sources of income will immunise investors against severe financial damage, even when prices drop or do not rise as expected.
Is Negative Gearing Still Worth It?
Whether negative gearing is a good investment strategy for you is a decision you should make based on your circumstances and needs, with the advice of an expert mortgage broker.
That’s why our Home Loan Experts are here. Call us at 1300 889 743 or fill our free enquiry form so we can help you learn more about the best investment strategy for you.