Is Negative Gearing Worth it?

By Moye PM Team
Published in Property finance
December 30, 2020
6 min read
Is Negative Gearing Worth it?

As a property investor, you have a variety of financing alternatives. While you’ve undoubtedly heard a lot about negative gearing, you may not understand what it means for your business. And, with thousands of dollars on the line (not to mention the possibility of paying a hefty tax bill on your investment property), it’s critical that you make an informed decision.

Negative gearing is a tax strategy that allows you to offset your income and lower your tax burden. However, before you decide to negatively gear your investment property, you must first grasp how this investing method works. Furthermore, there is a strong dispute about whether or not this investing technique should be permitted to continue in its current form in the future.

In this guide, we’ll go through negative gearing in detail, including the benefits and drawbacks of the strategy, as well as the tax and legal ramifications for you as an investor.

What is negative gearing?

When the money you earn from your property investment (usually rental income) is less than your expenses, you have negative gearing. As a result, you experience a yearly net loss.

How does negative gearing work?

Negative gearing is a method that can be utilised for a variety of investment kinds, however it’s most usually associated with property.

Let’s speak about gearing for a moment. Gearing is a term used in finance to describe borrowing money to purchase an item (such as property).

You are spending more in mortgage and property expenditures than you are receiving in rental income if you are negatively gearing your property. This implies your earnings are no longer taxable, and you can deduct your costs from your taxes.

Despite the fact that negative gearing is the most common property financing option, the percentage of negatively geared investors is at its lowest level in 14 years.

Negative gearing has proven to be a popular alternative for Australian investors, despite the fact that it may seem contradictory. According to the Australian Financial Review, 60 percent of property investors are negatively geared.

Let’s take a look at both sides of the argument to see why investors might (or might not) opt for this investment plan.

Despite the fact that negative gearing is the most common property financing option, the percentage of negatively geared investors is at its lowest level in 14 years.

Negative gearing has proven to be a popular alternative for Australian investors, despite the fact that it may seem contradictory. According to the Australian Financial Review, 60 percent of property investors are negatively geared.

Let’s take a look at both sides of the argument to see why investors might (or might not) opt for this investment plan.

What are the benefits of negative gearing?

Negative gearing has two key advantages:

  1. Tax benefits: as an investor, you’ll be able to deduct any losses you incur on your investment property from your taxable income, lowering your property tax burden.
  2. Capital gains: When it comes time to sell, investors hope that their property will increase in value, allowing them to make a profit that offsets the losses they’ve sustained throughout the course of the investment.

Read our advice on how to earn the greatest tax deductions from your investment property if you’re seeking for more ways to save money.

What are the drawbacks of using negative gearing?

Negative gearing, on the other hand, has various drawbacks, including:

  1. Reduced cash flow: You won’t be able to produce a passive income from a negatively geared property because you’ll always be losing money. This can have a negative influence on your cash flow, making it difficult to afford the price of upkeep, repairs, and unexpected bills.
  2. Negative gearing’s ultimate goal is for the property to increase in value, however this does not always happen in practise. Negative gearing can leave you more sensitive to losses as the market changes (rather than providing stable and consistent returns over the lifetime of the investment).

What additional options do you have for finance?

While negative gearing gets the most attention, there are a variety of other ways to invest in real estate, each with its own set of benefits and drawbacks.

Positive gearing explained

Positive gearing, as you might think, employs the opposite strategy. The money you borrow to invest and the income you earn from your investment are both greater than your expenses in this situation.

Positive gearing can provide a reliable source of passive income if you’re searching for stable, consistent earnings. Furthermore, if the value of your property increases, you may be able to sell it for a profit.

However, because of the additional income, you may be required to pay tax on your investment earnings (which is something you’ll want to avoid as an investor). It’s also more difficult to identify homes that fit this strategy, so you may need to expand your search to smaller, regional areas (where capital growth isn’t as strong).

Neutral gearing explained

What happens if the money you borrow to invest and the income you earn from it both equal your expenses? This is referred to as a neutral gearing strategy.

This means you’re basically breaking even, with no advantage or disadvantage in terms of the amount of tax you pay.

This method is advantageous for people investing through a self-managed super fund (SMSF) because it does not deplete the fund’s assets.

To be fully honest with you, neutral gearing is a very unusual occurrence. Realistically, it’s difficult to synchronise your income and expenses over the course of a year, especially when vacancies are taken into account. That is why, in practise, most property investors either intentionally positively or negatively gear their properties.

What tax consequences does negative gearing have?

One of the most compelling arguments for negative gearing is the potential tax savings. Investors in Australia can deduct their losses from their income to reduce the amount of tax they must pay when they file their taxes with the ATO.

As an investor, this means you can benefit from tax deductions such as:

Deductions from income (such as interests, maintenance expenses and recurring costs such as agent fees, cleaning costs and even insurance) Assets that depreciate (such as furniture, carpets, and curtains) Extensions, changes, or enhancements to your investment property’s earning potential are examples of capital works. In some situations, these savings might also be used to assist investors expand their property holdings.

Many investors who have a negative equity position in their property are hoping to profit when it comes time to sell. Making a capital gain, on the other hand, entails tax liabilities (known as capital gains tax).

This means that any capital gains you make are added to your personal income, which can significantly raise the amount of tax you owe. If you want to lower your tax bill, you should be aware of capital gains tax (CGT) and how it may affect your returns when you sell your investment property.

As a result, tax season becomes more challenging. If you’re concerned about this, a property manager can assist you.

While negative gearing has some advantages for investors, it is not without its detractors. Negative gearing, according to critics, is worsening housing unaffordability by raising property prices and making it difficult for first-home buyers to get a foot in the door.

Both political parties have taken a strong stance against negative gearing in recent years. Prior to the 2019 election, Labor sought to kerb negative gearing, while the Coalition worked aggressively in the opposite direction to preserve negative gearing.

According to recent ATO data, more than a quarter of Australians earning above $80,000 claimed nett rent losses (compared to only 13.1% of those earning less than $80,000). Negative gearing is most beneficial to those with greater earnings, according to this data.

In order to increase the supply of affordable rental property in Australia, several pundits are now urging the government to change the tax benefits offered to negatively geared dwellings.

While negative gearing is still a viable choice for investors, legislative revisions and tax implications may be a topic of discussion in the coming years.

Is negative gearing worth it in the end?

Negative gearing can be a useful method for lowering your tax burden and unlocking potential capital gains, but it comes with a number of drawbacks.

Negative gearing can be a viable approach to consider if you’re ready to tolerate a higher level of risk and can live without consistent rental income. Negative gearing can also assist you decrease your tax liabilities, ensuring that you don’t overpay on your investment property.

To determine whether a negative gearing approach is the greatest solution for your needs, you’ll need to analyse your unique personal financial circumstances and investing goals.

Disclaimer: The views, information, or opinions expressed in this blog post are for general information purposes only and should not be relied upon. We have not taken into account specific situations, facts or circumstances, and no part of this blog post constitutes personal financial, legal, or tax advice to you. You should seek tax advice from your accountant, specific to your situation.


Previous Article
6 Tax Saving Tips for Your Investment Property
Moye PM Team

Moye PM Team

Table Of Contents

1
What is negative gearing?
2
How does negative gearing work?
3
What are the benefits of negative gearing?
4
What are the drawbacks of using negative gearing?
5
What additional options do you have for finance?
6
What tax consequences does negative gearing have?
7
Is negative gearing legal (and will it always be)?
8
Is negative gearing worth it in the end?

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