It’s not hard to find articles, advice, and opinions about negative gearing, particularly in the current Australian political environment.
Some people think it’s primarily a tax minimisation strategy, others see it as the only way to get into property investment. Then some will tell you that it’s an extremely risky investment strategy, while others tell you how great it is.
While some want you to believe that it only benefits the wealthy, others happily point out how many people who claim negative gearing tax benefits earn less than $80,000 a year.
If you’re not confused about negative gearing, congratulations. If you are, you’re not alone … and hopefully we can help make things a bit clearer.
- What is negative gearing?
According to the Australian Taxation Office “A rental property is negatively geared if it is purchased with the assistance of borrowed funds and the net rental income, after deducting other expenses, is less than the interest on the borrowings”.
- Why are there tax benefits?
The government is providing an incentive to investors to take greater risks, by allowing someone who loses money on their investment property to claim that loss against their overall income.
- So does the government want more people to own more property?
Pretty much. The Australian government doesn’t provide a great deal of social housing, as some other countries do, but our population keeps increasing. By recognising property investment as a business, and offering some tax incentives to people who go into that business, the government is encouraging the private sector to fill the demand for rental housing.
- Does this only happen in Australia?
While many other countries offer tax benefits to people who buy property, Australia, New Zealand, and Japan are the only ones that allow investors to carry losses across asset classes, so that the real estate investment loss becomes a valid deduction against personal income.
- Is most investment property negatively geared?
No, there are plenty of people who invest in property “positively” – that is they still borrow money to buy the property, but the rent they receive covers all of their costs (interest on the loan, insurance, rates, body corporate fees, etc.) so their investment is bringing in extra cash each year.
- Why do people negatively gear?
Obviously the tax incentives are attractive, otherwise no-one would be taking advantage of them, and there are a lot of people who are planning for their future who can afford to be making small losses each year with a view toward the bigger picture: a substantial capital gain when they eventually sell the asset.
- So why don’t all property investors do it?
Those who are able to positively gear are essentially earning money two ways: through rental income and through the appreciation of the asset; that is the rise in the value of the property. Negative gearing, on the other hand, rules out one of these ways of making money.
- Do you have to do one or the other?
An investment might start off negatively geared, but after some years it can turn positive, for example when the rent goes up and/or the interest payments are reduced (due to paying down the principal).
- Are there other financial factors?
Depreciation can be a significant factor, particularly for newer properties. By taking advantage of tax-deductable depreciation allowances on fixtures and fittings, an investor can further maximise the benefits of owning property.Of course, interest rates and inflation also play a significant role in the cost of buying, owning, and servicing property, across the board. Higher interest rates and higher inflation can make life difficult for some who has negatively geared their investments.
- What is the biggest risk of negatively gearing an investment property?
While there are several risks, the main one is probably the one that worries any property investor: having the property vacant for a long period. If you are getting no rental income, you still have to be able to make your loan payments, so that could start taking up a large chunk of your income.
- How does negative gearing impact property prices?
If there was no negative gearing, and therefore no incentive to own an investment property unless it was cash flow positive, it is likely that there would be fewer people looking to buy (and possibly a number looking to sell). The law of supply and demand suggests that with more properties available and fewer people looking to buy, property prices would be lower.
- How does negative gearing impact on rents?
Without negative gearing, most property investors would be asking for rents that at least cover their costs (neutral gearing), so overall rents would most likely increase. However if property values were to fall to the extent that investors would be borrowing less (and therefore making lower repayments), it is possible that rents would be at similar levels.
As with any investment or property buying decision, there are a lot of things to consider before you decide whether negatively gearing an investment property is right for you, and you should get some professional advice to help you make an informed decision.
Is negative gearing good or bad? (RealEstate.com.au, February 15, 2016)
How does negative gearing really work? (Australian Financial Review, August 21, 2015)
How to get two property income streams and why negative gearing is not so stupid (Your Investment Property Magazine)