If your interest and running costs add up to more than your investment income you make a loss which is called “negative gearing”.
The aim of this strategy is to benefit from getting into the market early and over time increasing your investment income to cover your expenses.
You are normally permitted to claim the net loss as a tax deduction against your other income.
Example of tax savings
For example, you are an employee who earns $80,000 in your job and owns a rental property. This property collects $20,000 per year in rent and costs $30,000 per year in interest and running costs.
The loss on the property of $10,000 reduces your taxable income from $80,000 to $70,000, thereby saving you 30% tax on that reduction, being $3,000. You can see that the after-tax loss on negative gearing is $7,000 and is cushioned by the tax reduction you receive.
It is possible for you to vary the tax withheld from your pay rather than to receive this tax saving as a refund at the end of the year.
Negative gearing has a major effect on the tax collected by the Australian government, reducing it by $0.6 billion in the 2001/2002 financial year, $3.9 billion in 2004/2005 financial year and $13.2 billion in 2010/2011 financial year.
Combining depreciation and negative gearing
Consider the same case, but here you also claim depreciation benefits on the property. Say your rental income is $20,000, costs are $30,000 and depreciation claim is $5,000. Your cash loss for the year is still $10,000, but your net rental loss for tax is $15,000.
Your taxable income reduces from $80,000 to $65,000, thereby saving you 30% tax on that reduction, being $4,500. So your after-tax loss reduces to $5,500.
The goal of investing is to make a profit!
If you are making a loss on your investment property each year then sure you’re saving on tax, however you are still losing money! The reason that investors often invest in negatively geared property is that the growth in the property usually outstrips the holding costs.
When you eventually sell the property you pay capital gains tax on the profit from the sale, however the tax benefits of negative gearing helps you to hold more investment properties without impacting your lifestyle.
Positively geared property
While most investors rely on the capital gain to make a profit, some hold their properties for long term in which case the properties often become positively geared.
This happens because the rent increases over time however the loan amount does not, so eventually the rent income is more than the holding costs of the property.
Some investors buy properties with exceptionally high rent returns which means they are positively geared from day one. In some cases these properties experience lower capital growth.
If a good property is picked then it may be possible to get the winning combination of a high growth rate and a high rental return.
Although positively geared properties do not have the same tax benefits of negatively geared property, keep in mind that the goal of investing is to make a profit, not to avoid tax.
For this reason positively geared properties are excellent investments if they also have high capital growth.
How do lenders assess negatively geared properties?
Did you know that some lenders do not take negative gearing benefits into account when assessing your ability to afford a debt? In addition to this most lenders do not use the full amount of your rent income in their assessment.
Professional investors should have a strategy in place to use several lenders to achieve their investment goals. This allows them to maximise their borrowing capacity, manage their exposure to each LMI company and lender as well as to avoid cross securitisation of their portfolio.
Can I move my home loan to my investment property?
What if you have a large loan on your home and no debt on your investment property?
Unfortunately you can’t just move your home loan onto your investment property and get a tax deduction.
The ATO looks at the purpose of the loan, not what it is secured on so moving the loan over doesn’t change what the funds were originally for and will not make the interest tax deductible.
Speak to an experienced accountant
This information has been provided by Lucentor Pty Ltd who are accountants that specialise in tax for property investors.
We recommend investors obtain financial advice specific to their situation before making any investment or decision regarding their finances.