Make Negative Gearing work for you
Posted by Peter Scarfo on Sun, Oct 09, 2011 @ 10:53 PM
When the dinner party discussion turns to investment property and negative gearing, do your eyes glaze over? Would you rather focus on the meal than join the discussion and risk getting it wrong?
Here’s a simple guide to negative gearing and how it works, so you can decide if it’s a strategy that could work for you;
- The term ‘gearing’ means funds are borrowed for an investment
- ‘Negative gearing’ means that the income on the investment is lower than the costs. In other words, the investment is making a loss.
Why would anyone consciously make a loss on an investment?
When it comes to property, there are two good reasons:
- In the short term, any loss on the investment can be deducted from other forms of income – like your salary - meaning you reduce your tax.
- In the longer term, the strategy enables you to buy and hold an expensive asset that grows in value over time – in the case of property, potentially doubling in value every 7 or 8 years based on past trends.
The key to whether this strategy is for you is cash flow. In other words, can you afford to hold an investment that loses money, despite that the loss will reduce your current tax, and enable you to make money in the longer term? If so, it could be the start towards getting set up for a comfortable retirement.
As an example, if you earn $70,000 a year, that amount is your taxable income. If you own an investment property where the costs exceed the income by $10,000 a year, this whole amount can be deducted from your taxable income, meaning you now pay tax on $60,000 a year.
If the investment property starts the year valued at $300,000, and grows by 5%, on paper you have ‘earned’ $15,000 on the investment, in one year alone. This is not taxable unless you sell the property after one year, in which case capital gains tax of 31.5% would be payable on half the gain.
In summary, four things have happened through negatively gearing:
- You have been able to invest in another valuable property through borrowing
- You have reduced your taxable income by $10,000, saving $3,150.00
- You have achieved $15,000 as a potential capital gain
- You have a tenant paying off a large portion of the borrowed amount.
If this sounds like a dream scheme, why doesn’t everyone do it? The short answer is ‘cash flow’. You need to be able to carry the investment because the costs are higher than the income.
The good news - the Australian Government encourages investments that rely on negative gearing in order to provide rental accommodation for people. Not only can you offset the loss against your income, you can also adjust your ongoing monthly income tax (PAYG) payments to reflect this which means more dollars in your pay packet.
In other words, the ATO will allow your employer to deduct less PAYG each month, so you don’t have to carry the loss all year until you get your refund. Instead, the refund gets built into your pay packet through an Income Tax Withholding Variation (ITWV).
McCarthy Group has helped hundreds of Australian families buy investment property using negative gearing as a strategy. Many have gone on to purchase multiple investment properties, which would not have been possible without the assistance of negative gearing and can now look forward to a secure and comfortable retirement.
Still not 100% sure on negative gearing? Download our Negative Gearing Guide or book a no-cost obligation-free consultation.
It could be the most valuable appointment you’ll ever make – and next time you can lead the discussion on negative gearing at dinner!