What is negative gearing?
How does negative gearing work?
The underlying principle of negative gearing is for your capital to grow over time to such an extent that it outweighs the initial monthly or yearly losses incurred when you first buy the property, when the rental income does not cover the outgoings (e.g., mortgage, insurance, rates, maintenance, etc.).
An example of a negatively geared investment
Working on the basis of an investor having savings of $100,000, here is a comparison between the capital growth potentially achieved over 10 years when depositing that sum in a term deposit or when using it to buy an investment property.
- Initial sum: $100,000
- Additional funds added annually: $5,000
- 3% interest compounded monthly (after tax)
- Total after 10 years: $191,711
Buying an investment property
- Initial sum: $100,000
- Additional borrowing for purchase: $400,000
- Total value of investment property: $500,000
- Annual after-tax expenses: $5,000
- 3% annual growth rate
- Total value of investment property after 10 years: $642,295
- Net profit after repaying investment loan: $242,295
This side-by-side comparison shows that given the conditions outlined above, after 10 years you would be $50,584 better off buying an investment property rather than simply depositing your savings in a bank.
How does negative gearing affect the tax I pay?
When you own a negatively geared investment property, any net rental loss after the holding costs and depreciation have been accounted for when set against your other income. Losses can also be carried forward to the next financial year. This means you reduce your annual tax burden while also building long term capital growth.
At the same time, a property that is negatively geared can ultimately return a positive cash flow, i.e., you can still derive income from it each month.
To do this, you need to make a PAYG withholding variation application to the ATO. This means you do not have to wait until the end of the financial year in order to claim back your expenses, but rather your weekly, fortnightly or monthly PAYG is adjusted to take into account the various holding costs incurred by your investment property. The outcome is that you will pay less tax each pay per period, which could in fact mean that you are making a small, regular profit once you account for your costs.
Is negative gearing right for me?
Negative gearing is a property investment strategy that suits the needs of those who are looking to grow their wealth over time, and where capital growth over an extended period is more valuable than positive cash flow in the short term. It is strategy designed to generate significant long term returns so that you do not need to build up as large a property portfolio in order to earn a substantial return on your investments.
However, is not necessarily the right strategy for everyone. For instance, there are fewer immediate benefits with regard to income and returns than if you pursue a cash positive investment strategy. There may also be greater risk, as you are relying on the value of the property appreciating to such a degree that it will cover any initial losses. In some instances, as you are not generating any income in the short term from your investment, this could impact on your ability to obtain further financing and so limit the growth of your property portfolio.