If you paid close attention to the 2019 Federal Election, you would be familiar with the term negative gearing. The election put negative gearing policy into question, with Labor including a proposal to limit negative gearing to brand-new residential housing. However, with The Coalition retaining their position, no changes to negative gearing were made.
What is negative gearing and how does it work?
Negative gearing is when someone borrows money for an investment, and the rental income is less than the interest repayments and expenses. An investor’s rental property can be positively or negatively geared.
When an investment property is negatively geared, the property’s expenses and deductions are more than the property’s rental return. This means that the investor is making a loss that is deducted from their taxable income for that financial year.
Whereas, for a positively geared property, the rental income produced by the property exceeds expenses. An investor of a positively geared property makes a gain that is included in their taxable income.
If it means making a loss, why do investors keep their negatively geared properties?
You must consider the sustainability of a negatively geared property in all your investment decisions. For investors in Australia, there are some benefits of having a negatively geared property, including:
- Reduction of taxable income: You can use the loss of a negatively geared property to reduce your taxable income and boost your after-tax cash flow. This can be beneficial in the short term and for rentvestors that are in the early stages of entering the market.
- Long-term capital growth: National property values have increased significantly over the past decade, and the current outlook suggests that they will continue to rise. While a negatively geared property does mean making a short-term loss, the investor can offset the losses by benefiting from the long-term capital gain of selling the property once its value increases.
How negative gearing works with tax depreciation
Investment property deductions include expenses such as interest payments, maintenance costs, insurance and property depreciation. Both capital works and plant and equipment deductions are included in property depreciation. You can find out more information on available plant and equipment deductions here.
Tax depreciation deductions can change a previously positively geared property to be negatively geared without incurring a further loss as depreciation is a non-cash deduction. Below is a simplified example to show how this works:
Example: Property gearing with and without depreciation
An investor earns $80,000 a year and pays approximately $17,500 in tax.
The investor receives $25,000 in rental income from their investment property. The taxdeductible expenses include interest expenses of $10,000, maintenance expenses of $10,000 and landlord insurance of $2,000. The property is positively geared with a $3,000 return.
By including depreciation, the investor was able to claim capital works and plant and equipment deductions in their tax return, which came to $6,000 for that financial year. This changes the previously positively geared property to be negatively geared with a $3,000 loss.
The investor’s tax liability decreases to approximately $16,500 rather than increasing to approximately $18,500 when positively geared.
A reliable pre-tax cash flow is key for a sustainable investment, and we recommend speaking with a financial adviser to determine your investment strategy.
If your goal is to hold onto a negatively geared property to benefit from the long-term capital gain, you must also be aware of the Capital Gain Tax (CGT) liabilities of making this profit. To find out more about CGT and how it works, we have included further information in the articles below.
For more information on tax depreciation and how it can maximise your tax return, request a quote or contact our specialist team on 1300 728 726.