#33 Borrow Smart Series – Negative Gearing: How It Works and How It Can Benefit You

Negative gearing is a popular investment strategy in the Australian property market that can offer significant benefits to investors when used wisely. This approach occurs when the rental income from an investment property is less than the interest on the loan used to purchase it, plus other associated property expenses. While it might seem counterintuitive to invest in a property that generates a loss, negative gearing can provide both short-term tax benefits and long-term wealth creation opportunities. Let’s delve into the key aspects of negative gearing and explore its potential advantages for property investors.

What is Negative Gearing?

Negative gearing occurs when the costs of owning and maintaining an investment property exceed the rental income it generates. These costs typically include:

• Mortgage interest payments
• Property management fees
• Maintenance and repair costs
• Insurance premiums
• Council rates and strata fees

When these expenses are higher than the rental income, the property is said to be negatively geared.

Key Benefits of Negative Gearing

1. Tax Deductions

One of the primary attractions of negative gearing is the ability to deduct losses against other income. Here’s how it works:

• The net loss from your investment property can be offset against your taxable income from other sources, such as your salary.
• This reduction in taxable income can result in a lower overall tax bill.

For example, if your property generates a loss of $10,000 in a financial year and your taxable income is $100,000, you can reduce your taxable income to $90,000, potentially saving thousands in tax depending on your tax bracket.

2. Capital Growth Potential

While negative gearing may result in short-term losses, many investors use this strategy with the expectation of long-term capital growth. The idea is that:

• The property’s value will appreciate over time, outweighing the ongoing losses.
• When the property is eventually sold, the capital gain can potentially offset the accumulated losses and generate a profit.

This approach relies on choosing properties in areas with strong growth potential and holding them for an extended period to maximize capital appreciation.

Considerations for Negative Gearing

While negative gearing can offer significant benefits, it’s crucial to approach this strategy with a clear understanding of its implications:

• Cash Flow Impact: You’ll need to cover the shortfall between rental income and expenses out of your own pocket, which can strain your cash flow.
• Market Risks: The strategy relies heavily on property value appreciation, which isn’t guaranteed and can be affected by market fluctuations.
• Policy Changes: Tax laws and regulations around negative gearing can change, potentially affecting the strategy’s viability.
• Interest Rate Sensitivity: Rising interest rates can increase your losses and the amount you need to cover out of pocket.

Maximising the Benefits of Negative Gearing

To make the most of a negative gearing strategy:

1. Choose Properties Wisely: Look for properties in areas with strong growth potential and consistent rental demand.
2. Understand Your Financial Position: Ensure you can comfortably cover the ongoing losses without putting undue stress on your finances.
3. Regularly Review Your Strategy: As your financial situation or market conditions change, reassess whether negative gearing remains the best approach for you.
4. Consider Depreciation: Take advantage of depreciation deductions to maximise your tax benefits without impacting your cash flow.
5. Plan for the Long Term: Negative gearing is typically most effective as a long-term strategy, allowing time for capital growth to accumulate.

Seeking Professional Advice

Given the complexities of negative gearing and its potential impact on your financial situation, it’s crucial to seek professional advice before implementing this strategy. Consider consulting:

• A mortgage broker to help structure your loan effectively and find competitive interest rates.
• A tax advisor or accountant to understand the tax implications and ensure you’re maximising your deductions legally.
• A financial planner to assess how negative gearing fits into your overall wealth creation strategy.

These professionals can provide personalised advice based on your specific circumstances, helping you make informed decisions about whether negative gearing is right for you.

Conclusion

Negative gearing can be a powerful tool for property investors, offering the potential for tax benefits and long-term wealth creation through capital growth. However, it’s not without risks and requires careful consideration and planning. By understanding the principles of negative gearing, assessing your financial position, and seeking professional advice, you can determine whether this strategy aligns with your investment goals and risk tolerance. Remember, successful property investment is about making informed decisions that align with your long-term financial objectives. Whether negative gearing is the right approach for you will depend on your individual circumstances, financial goals, and the specific properties you’re considering.