Getting Into Gear - Negative Gearing Explained

With close to half-a-million property investors around Australia, using other people’s money to increase personal wealth is almost a way of life in this country.

Whilst Negative Gearing is commonly associated with rental properties, it can also be applied to other types of income-producing investments such as shares and managed funds. By definition, negative gearing is where the interest paid on borrowed funds each year is greater than the income generated by the investments. The investor therefore ‘creates’ a tax deductible loss to offset against their other sources of income.

To illustrate this point, let’s imagine you buy a $350,000 property in Melbourne and borrow an additional $17,000 to cover the stamp duty and legal fees on purchase. Assuming you could get $350 rent per week on the property and the mortgage rate was 7.35% the financial scenario could be as follows:

Rental Income   $ 18,200
52 weeks @ $350 per week    
Agent’s Fees – 7% of the Rent $ 1,274  
Loan Interest - $367,000@ 7.35% 26,974  
Rates 2,000  
Insurance 800  
Repairs & Maintenance 1,200  
Sundry Other Costs 1,000 $ 33,248
Tax Deductible Loss   $ 15,048

For gearing to work the price of the asset must rise over time. Gearing up simply for tax purposes is a big mistake because if the investment loses value you not only lose your own capital but you also have a residual debt to repay.

Every investment carries some degree of risk due to economic forces beyond your control and selecting a good investment takes time, knowledge and experience. To assist you we provide the following general guidelines:

  1. Always seek the advice of a licensed independent professional.
  2. Buy good quality investments, preferably with a reliable and increasing income stream.
  3. Negative gearing by definition implies a loss making venture so borrow conservatively so you can survive interest rate rises and the possible loss or change in income. (e.g. starting a family and reverting to a single income household).
  4. Maintain your income from your employment (or other sources) to cover your borrowing costs, especially in the early years.
  5. Talk to us about the most tax effective way to structure your loan - principal and interest (P&I) or interest only. We can also refer you to our affiliate mortgage brokers to source you the right loan that could potentially save you thousands of dollars.
  6. Using a property analysis software program we can prepare cashflow projections, produce a 10 year taxable income forecast and even apply to have a reduction in your PAYG tax to reflect the anticipated tax loss. We can also explain the capital gains tax implications of your investment and advise whose name to buy in. If you are interested in finding out more about negative gearing call our office today and make an appointment.

IMPORTANT DISCLAIMER: This article is published as a guide to clients and for their private information. This article does not constitute advice. Clients should not act solely on the basis of the material contained in this article. Items herein are general comments only and do not convey advice per se. Also changes in legislation may occur quickly. We therefore recommend that our formal advice be sought before acting in any of these areas.