While negative gearing is a method commonly applied to rental properties, it can in fact be applied to any type of investment.
Essentially, negative gearing is when you borrow money to invest (let’s use the example of property), and you operate at a loss, i.e. your rental income is less than what it costs you to hold the property.
When it comes to rental properties, there are a number of things you can claim as a deduction in an effort to boost your costs and come out “negatively geared”.
- Your mortgage interest repayments (note: repayment of principal is not a deduction)
- Property management / real estate fees, which may include advertising for new tenants
- Body Corporate
- Land tax
- Cleaning between tenants
- Electricity, gas and water (while it’s rented, or even just available for rent)
- Maintenance, which may include repairs, gardening costs, pest control, servicing smoke alarms or air conditioners
- Any tenant related legal expenses
- Administrative costs such a phone calls, stationery, postage
- Tax Agent and Bookkeeping fees
- Quantity surveyors
- Capital Works
- Mortgage discharge costs
- Purchases for the property less than $300
- Depreciation of purchases for the property over $300
Tax considerations when you negatively gear
When it comes to tax, negative gearing can be beneficial as your out-of-pocket expenses (i.e. the amount remaining when you deduct your rental income from your property costs) can be offset against other income, such as your salary, to reduce your taxable income and therefore how much you pay in tax. It’s a popular strategy amongst investors for this very reason.
If Sally takes out a loan to buy a new investment property and she receives $26,000 in rental income across the year, but it costs her $36,000 in interest, rates, insurance and other property-related expenses, she is operating at a loss of $10,000.
Sally earns $100,000 per year and would generally pay $24,997 in tax. But by negatively gearing her property, she can use her $10,000 loss to reduce her taxable income to $90,000, bringing the tax she pays down to $21,547.
This means it has only cost Sally $6,650 to hold her investment property for the year, instead of $10,000, due to her tax saving of $3,450.
Making a loss on an investment may seem counterproductive, but between the tax advantages and the capital gain (the amount you sell your asset for minus how much it cost you), together these can offset any loss incurred while holding the property.
It’s important to note that as a property investor, you will pay tax on your rental income, in addition to any profits made when you decide to sell (your capital gain). This is called Capital Gains Tax. However, there are some concessions available to longer term property investors that can reduce the amount of capital gain that is taxable.
When deciding on the best investment strategy for your situation, you should always seek personal advice from your Financial Advisor, as well as your Accountant to better understand the tax implications.
If you’d like to discuss negative gearing to reduce tax further, please don’t hesitate to Contact Us.
*Disclaimer: This information is for general information only, it has been prepared without taking into account your personal circumstances and should not be taken as constituting professional advice. Lemonade Beach is not a financial adviser. You should seek independent financial advice to check how this information relates to your personal circumstances.