Negative gearing is a commonly used term to describe a situation when the income earned from an asset is less than the expenses of holding that asset during the same period of time. Negative gearing can apply to any investment, not just housing.
An investment property is negatively geared when the income earned i.e rental income, is less than the expenses paid out for holding the property. Expenses include interest on the investment loan, property management fees, depreciation, repairs and maintenance, advertising, professional cleaning etc.
An example of a negatively geared property:
The table above shows that the property is negatively geared and includes deductions for capital allowance and depreciation. Learn more about the relationship between depreciation and negative gearing here.
Why do investors negatively gear investment properties?
Negative gearing is typically not the objective of most property investors. There are a few circumstances that can give rise to a property investor being negatively geared. We’ll look at each below:
Short-term pain for long-term gain
People choose to invest in property with the expectation that the value of their asset will increase over the long-term. They recognise, that in the short-term, with high loan repayments and other expenses, that they may be worse off in terms of cash flow, but they are anticipating that the increase in the value of their property over time, will outweigh the costs of holding it. Many investors will tolerate being negatively geared for a number of years early in the investment, recognising that as they pay down their loan, and slowly increase rents over time, they should ultimately end up in a positively geared situation.
Unplanned negative gearing
Some investors never intend for their investment property to be negatively geared. Property investment can be risky however and if a property is unable to be rented for a period of time unexpectedly (due to property faults that make it unsafe, natural disasters, destructive tenants, vandalism, market conditions etc) then investors can easily find themselves in a situation where the costs of holding the property are greater than the income received i.e negatively geared.
Some high income earners choose to invest their surplus funds in property (as opposed to superannuation, shares etc). Their accountant may advise that a negatively geared property (when they pay out more than they earn for the property), is an acceptable option as the loss made on the property is deducted from their taxable income. Investors that have these high incomes may also be encouraged to spend on property maintenance and repairs as they can afford less cash return from the property in that year, and may be less concerned with achieving highest possible rents as that will result in more income and more income tax payable.
How does negative gearing work?
When a property is negatively geared (makes a loss for the year), that loss is claimable as an investment loss when preparing your tax return.
As an example:
Should you negatively gear your investment property?
The answer to this can depend on who you ask.
Advantages of negative gearing
The key advantage of negative gearing is that there is some amount of tax relief available for having held a loss-making asset for the year. This is helpful for investors who are focusing on long-term investment returns, rather than short-term cash returns.
It is generally agreed that without negative gearing the pressure would be on investors to ensure that investment property income is always greater than total expenses. This can lead to upward pressure on rents, a greater focus on discounted services when it comes to property management and investment loans, and less incentive to spend money on repairs and maintenance.
Some investors and experts would argue that negative gearing contributes to improved rental affordability and an increase in property supply, as investors finance approximately 30% of all new properties constructed (according to the Real Estate Institute of Australia and ACIL Allen Consulting). Increased supply should theoretically help to keep purchase prices and rents down.
Disadvantages of negative gearing
The key disadvantage of negative gearing is the reduced tax payable by investors to the government. Some would argue that investors are being “subsidised” for holding loss-making investments. Additionally, the Capital Gains Tax Discount means that those tax savings are never properly clawed back by government even when the property is sold.
Many people also argue that the ability of investors to negatively gear a property creates greater competition for home purchases and puts upward pressure on house prices. Some commentators argue that investors primarily purchase second-hand property which creates greater competition in this market, pushing prices up. It should be noted here that this has been countered slightly with changes to depreciation legislation that no longer allow the depreciation of second-hand assets to be claimed as a tax deduction.
Negative Gearing Summary
Negative Gearing Summary
Negative gearing describes a situation where the expenses of holding an investment property (or any investment asset), are greater than the income derived from that asset.
Some investors hold negatively geared property with the expectation it will become positive over time (short-term pain for long-term gain), whilst others find themselves negatively geared unexpectedly, or choose to negatively gear as part of their tax planning.
When an investment property is negatively geared, the loss made that year is claimable as a tax deduction against other assessable income.
There are a number of advantages and disadvantages for the economy when it comes to allowing investors to claim negative gearing as a tax deduction.
Claiming Depreciation is a key part of a negative gearing strategy
Depreciation is one of the largest tax deductions available to investors and therefore a key aspect of a negative gearing strategy. Because depreciation is a calculated “written down value” you don’t need to have spent money on the property to claim it as a tax deduction. Learn more about the relationship between depreciation and negative gearing here – tables and examples provided.
Have you been claiming depreciation on your rental property?
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