Once you’ve achieved solid personal finances- a steady saving schedule, limited consumer debt, maybe your own home- you’re probably looking to build on these advances. Saving money for retirement is one kind of investment but, in order to grow your wealth, you might consider looking at other avenues for investment. In order to take full advantage of investment opportunities, it’s important to look at ways the tax system can benefit you. Negative gearing is one of the more powerful ways to assist your investment opportunities.
That’s one side of the coin. The other side of negative gearing, critics suggest, is that it is a system that helps the rich get richer, while keeping first-home buyers out of the property market and at the mercy of renting. Here is a concise guide to negative gearing- what it is, how it can benefit you and the potential pitfalls of the system.
What is negative gearing?
You’ve decided to buy an investment property. You’ve borrowed the money, bought the place and rented it out. At the end of the year, if your net rental income (the rent it accrues minus all your expenses) is less than the interest you are charged for the loan, you’re entitled to negative gearing.
This means you’re at a net rental loss. Which, in turn means, you’re eligible to claim this loss as a tax deduction against your income.
In some cases, negative gearing also applies when you’ve taken out a margin loan to invest in shares. As that is a less common method, and one that involves financial risk, this article will concentrate on negative gearing for investment property.
Ok, but what does negative gearing really mean?
It means that the losses you accrue on your investment are covered in taxation. This includes the interest you pay on your loan. In other words, the government is basically absorbing a significant amount of the cost of your investment by reducing your tax, until that investment starts making a profit.
Put very plainly, between the rental income and tax deductions, you can own an investment property without any real cost to you. Any difference between what you earn and what you pay is covered by tax, so you can sit pretty and wait for the capital gains to accrue (or until you’ve paid off the loan and the rental earnings are profit).
What can I claim when negative gearing?
If you’re the new, proud owner of an investment property, it’s a good idea to get familiar with what you can claim as expenses for your property.
These expenses include:
- Stamp duty and legal fees on the mortgage
- Strata costs
- Council rates
- Cleaning costs
- Depreciation of fittings
- Land tax
- Insurance costs
- Maintenance costs
- Water rates
- Travel costs
- Property management costs
As you can see, the list is extensive. It also probably necessitates a good accountant, comfortable with the procedure, who can ensure that you’ve claimed all the expenses you’re entitled to.
How negative gearing can help you and work for you
Negative gearing is a way to make investment more achievable. It’s also a means to ensure long-term investment, over short or medium term strategies.
For some investors, usually those who invest in several properties, will only pay off the interest and not the capital of the loan. This is one strategy. Your property is still eligible for negative gearing, and you’re relying on capital gains to provide the profit once the property is sold.
Another method is to pay off the interest and the mortgage. While still entitled to capital gains once the property is sold, you’ll also have created extra space between the sale price of the property and the amount you still owe on it, meaning it can stand as a long-term saving option.
Negative gearing into retirement
For some people, a negatively geared property is another means of saving for retirement If your contributions for super are at an age-appropriate rate, perhaps an investment property could be another option for investment in your retirement.
Obviously, it is essential to choose your property carefully. If you’re looking for the investment to assist your retirement, you’re hoping for high rental return or strong capital gains (or both). Whether you choose to maintain the rental income or sell the property and live off the earnings, it’s worthwhile talking to a financial advisor about whether buying an investment property now could be a smart way to improve your income flow in retirement.
The problem with negative gearing
Money has the tendency to make money. That’s fantastic if you’ve got a lot of it, and not so great if you’re struggling to save some cash at the end of the month.
Critics of negative gearing in Australia say it has contributed to obvious trends in the capital cities- making it harder for first-home buyers to afford to buy a house or apartment, increasing the amount of people and families remaining in the rental market and widening the gap between owner-occupiers and renters in terms of wealth and opportunity.
In a large part, these are claims that have a fair amount of truth in them. There are incredibly low rental vacancy rates in capital cities while property markets soar, making it harder for the new generations to get a foothold in the property market.
But before we throw up our hands, here are some ways to think about how you might join the owner-occupier side of the equation in order to start the process of moving to take advantage of negative gearing (something that both sides of Parliament are promising to leave untouched).
- Consider moving further out of the cities to an area more affordable, in order to get into the property market more easily
- Consider what you really need in a house. One bedroom? Two? It’s just to get a foothold, you can buy the mansion later
- Get out of consumer debt now. Think it’s just the weekly rent that’s stopping you from buying your own home? Think again. Consumer debt is the money you could be putting towards a house deposit instead.