There are many reasons why property investment in Australia has traditionally been seen as a lucrative venture. Our country has a growing population and a housing undersupply that is well reported.
What Is Negative Gearing?
When the cost of owning an investment property exceeds the income received from it, the Australian Tax Office allows investors to offset the loss against their personal income. This is what is known as negative gearing.
Essentially it means that while you may earn a loss on your investment, this loss can be used to reduce the tax you pay on your income. You may be able to deduct expenses such as loan interest and setup costs, in addition to insurance, repairs and property management fees.
Although it seems quite straightforward, negative gearing is actually quite a complicated topic. Many investors are allured by the immediate prospect of paying less tax on their income without fully understanding the consequences of not having positive cash returns on their property.
What are positive cash flow returns? This is when your rental income is greater than the combined expenses of holding and renting out a property. Basically there are two ways to make money from property investment: positive cash returns on your investment and capital appreciation (where your asset increases in value).
The downfall for many investors is restricting themselves to the benefits of negative gearing while disregarding positive cash flow returns. This means one of the two major sources of capital growth is diminished and the risk of not making a profit from an investment increases.
Like we said, investment in Australia has traditionally been seen as a lucrative venture, but of course, the market can never predicted with absolute certainty. Therefore, decreasing risks in your portfolio is crucial. And this is why negative gearing may not always be what it first seems.
Be sure to discuss with your accountant the different tax benefits associated with property investment. They will be able to advise based on your personal circumstances to help you make smart decisions.
Here at Optimal, we always look to find properties that can generate free cash flow as soon as possible. Remember the goal here is to create tangible wealth, not just minimise tax!
What Investment Expenses Can You Claim As a Tax Deduction?
When considering the benefits of negative gearing you will want to consider what investment expenses you can claim as a deduction at the end of the financial year.
Generally speaking, you can claim a deduction for any expenses associated with the management and maintenance of your property. This includes the interest you are pay on your loan, your rental income, and your personal income.
The possible deductions are usually split into three major categories:
• Capital items: This includes items such a built-in dishwashers, stoves or fridges and other similar amenities. As these products tend to depreciate over time, they can be claimed over several years.
• Revenue: This includes deductions on the interest you pay on your mortgage, maintenance fees, rates, advertising for tenants, council rates, body corporate fees and so on.
• Building allowances: Generally, you can also claim for building allowances.
These three categories encompass a huge scope of items that can be claimed as a tax deduction at the end of the financial year. Again, you can discuss all of this with your accountant or financial planner. There is also a comprehensive list on the ATO website that you can look at.
The Pros and Cons of Negative Gearing
• Tax benefits – Essentially, negative gearing you can turn a loss into a gain by offsetting your investment against your income and thus pay less tax.
• The potential for capital appreciation – If you have enjoyed benefits of negative gearing in the short term and the value of your property increases enough over time to cover the losses sustained from during the investment term, then the investment would be seen as quite lucrative.
• A stable strategy – For experienced investors with a sound strategy and the financial means to absorb the losses over the long term, then negative gearing can be very advantageous.
• Favours high earners – Negative gearing typically benefits high-income earners who have the capital means to absorb losses over the long term without compromising their financial stability.
• Risks – As with any investment, there are risks involved with investing in property such as rising interest rates or property depreciation.
• Economics – Many critics have scorned negative gearing for driving property prices while doing little to improve housing supply. Negative gearing encourages more people to borrow money and can potentially destabilise the economy.
So, Is It a Good Investment Strategy?
At Optimal, we are always looking to find properties that can generate free cash flow as soon as possible for our clients. We believe the goal of property investment is to create tangible wealth, not just minimise tax and therefore we believe that negative gearing is not always the best option.
Of course, negative gearing as a good investment strategy depends on a range of factors and you will need to have a first grasp on how it works before you should consider it. If it is something that sounds like it may benefit you, be sure to discuss thoroughly with your financial planner or accountant.