Negative gearing and tax implications
If you've got money to invest, one of the options you may consider is negative gearing. With correct financial advice and with the selection of the right property, negative gearing can provide great tax advantages. That's great if you're thinking about entering the property investment market for the first time, or want to increase your investment portfolio.
How do you negatively gear a property?
A property is negatively geared when the costs of owning it – interest on the loan, bank charges, maintenance, repairs and capital depreciation exceed the income it produces. Put simply, your investment must make a loss before you can claim a tax benefit.
It works not only for property, but also shares and bonds.
Investment expenses that you can claim as a deduction
Property owners can claim deduction and depreciation against income on the property. There are three main classes of deductions available to investors:
1. Revenue deductions – These include interest on the loan as well as ongoing maintenance and recurrent expenses such as agent’s fees, council fees, advertising charges, bank fees, body corporate fees, cleaning expenses, gas, water, gardening and insurance.
2. Claims for capital items – Large capital items such as a hot water service, white goods, etc are subject to depreciation. This means the owner must claim the cost over a number of years rather than all at once. Depreciation schedules are set by the Taxation Department and range from a few years to more than 20 years.
3. Claims for building allowances – Owners can also claim depreciation of capital works, specifically for building and landscaping. The current rate is 2.5% over 40 years.
Risks associated with gearing
There is an inherent risk associated with borrowing to fund an investment. While gearing can help you increase your gain on borrowed funds, the losses can be large in adverse circumstances. As a general rule, only investors with the financial capacity to absorb the effect of potential falls in investment values, as well as an increased cost in interest payments, should consider negative gearing.
You can minimise the risk of gearing by:
Choosing your investment property carefully. You need to try and select a property that is likely to increase in value throughout the investment period.
Having a sufficient income to cover the interest repayments if your tenants are late with their rental payments, or if your property remains vacant for any time. You also need to be able to fund ongoing repairs and maintenance.
Taking out Mortgage Protection Insurance with your investment loan.
Example
Rental income on investment property $2,000 per month
Less
Expenses (interest, maintenance etc) ($2,500) per month
Council rates and other expenses ($100) per month
Shortfall $600 per month
This example shows how an investment asset may be negatively geared. The net loss of $600 per month ($7,200 per annum) may be claimed as a tax deduction.