8 Things to Know About Negative Gearing
This guest post comes from Australian writer Rob Chaloner
Who doesn’t want to invest in property or have a more extensive property portfolio? It’s the dream of many Australians, and there are a few different ways of going about it.
One of the most popular ways of making this happen is through a strategy called negative gearing. Continue reading for eight important things to know about negative gearing.
1. It’s a tax strategy
It’s important to know what negative gearing actually is. Don’t be fooled. Negative gearing does not have anything to do with gears in a car. The term actually refers to a tax strategy that is used frequently in Australia.
The Australian Taxation Office explains it as follows. “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.”
A “negatively geared” property is a property which has expenses that are more costly than the income it produces. In other words, expenses like interest on the loan, bank charges, agent fees, maintenance, repairs and capital depreciation add up to more money than the rental income earned from the property.
In other words,it is when the net income (after subtracting expenses) is less than the interest on the borrowed money.
2. Property speculators mostly use negative gearing
Property speculators frequently use negative gearing. That being said, those who work with shares, bonds and other investments can also reap the benefits of negative gearing.
It isn’t just the wealthy who use negative gearing when investing in property. Teachers, engineers, nurses and midwives also use this wealth creation strategy. It’s popular because it allows them to purchase property while also saving on tax obligations that come from their salary.
3. Negative gearing offers the possibility of significant tax benefits
So, what are these tax benefits that negative gearing allows for? After all, they are the main reason that people seek to make this type of investment.
For example, if you opt to negatively gear a rental property, then the rental expenses you declare in your tax return would produce a tax refund. This would then decrease your rate of withholding to match your year-end tax liability.
4. The Australian government encourages negative gearing
Many countries have tax benefits for people who buy property. But negative gearing is unique to Australia, New Zealand, and Japan. You can transfer losses across asset classes in these countries. In the United States (and elsewhere) this is not possible.
The Australian government is (essentially), encouraging potential investors to invest, and to take more significant risks than they otherwise could.
Negatively geared investments often become positively geared over time. This may happen when the rent goes up, or the interest payments are reduced (due to paying down the principal).
5. Negative gearing allows investors to focus on high growth areas
One of the greatest advantages of negative gearing is that it allows investors to focus on high growth areas. Australia is a growth market, which means that negatively geared properties are abundant.
For this reason, investors look into these top target areas that have high growth potential so that you can get that capital growth.
Additionally, negative gearing can enable a potential investor to acquire property in the most stable and sought-after areas. Negative gearing gives you a chance to obtain the properties that are highly desirable, such as capital cities, that will likely be more stable with pricing as there is a significant demand for housing.
6. Negative gearing enables you to expand your portfolio
There are always risks with investment. However, if you are able to obtain the capital growth that you desire, negative gearing provides you opportunity. You can leverage against that, in turn enabling you to earn more substantial returns and then continue expanding your portfolio.
This becomes a possibility because as your home (hopefully) increases in value, then it becomes conceivable to borrow against that greater value in order to utilize that as a deposit on an additional property. Voila! You have an expanded portfolio without needing to introduce any more funds into these investments.
7. Negative gearing makes property prices higher
If negative gearing wasn’t available in Australia, and the only motivation to own an investment property was cash flow positive, then most likely, there would be fewer people in a position to buy property, and a lot more looking to sell their properties.
With a quick look at the fundamental economic law of supply and demand, this implies that when there are more properties that are available and fewer people are able to buy, property prices would be lower.
Therefore, negative gearing means that fewer properties are available and more people are able to buy, which makes property prices higher.
8. Negative gearing has inherent financial risks
While negative gearing may seem like the easiest way to get into the property market, there are several risks when taking on this type of investment.
The main risk is that your property may remain vacant for long periods. This is problematic because you’ll still need to make your loan payments, and if you’re not receiving any rental income, this can impact your savings or cash-flow significantly.
Therefore, you should consider your capacity to repay these loans even if the property ceases securing any return. Just like you need to use a car loan repayment calculator before opting for a car loan, you need to spend time figuring out your repayment schedule for these loans.
It is essential that you speak with a professional financial adviser. You can then review which strategies are aligned with your financial objectives and risk preferences.
Have you ever considered using negative gearing? Why or why not? Let’s start a discussion in the comments below!
Author Bio
Rob Chaloner is the Founder and Managing Director of Stratton, and is passionate about smarter ways to buy and finance cars. With Stratton, he’s working to help Australian buyers disrupt the traditional car buying, financing and insurance markets through smarter products and online services.
