Introduction
Calculating the financial impact of an investment property can be overwhelming, especially when determining if it will be negatively or positively geared. Many investors find themselves confused by complex calculations and unclear outcomes. Negative gearing is a widely used strategy among Australian property investors, but understanding how to calculate it can be challenging.
In this blog post, we aim to simplify the process by providing a step-by-step guide on how to calculate negative gearing for your investment property. Whether you're new to property investment or looking to improve your existing strategy, our blog will help you navigate negative gearing with ease and make informed financial decisions.
Key takeaways
- Negative gearing occurs when the rental income from an investment property is less than the costs associated with the property.
- Calculate negative gearing by totaling property income, deducting expenses, and accounting for depreciation.
- Investors expecting a loss can apply for a PAYG Withholding Variation from the ATO.
Understanding negative gearing
First, let's clarify what 'gearing' means. It involves borrowing money to invest in assets like property. When you own an investment property, you typically rent it out to earn income. However, if the rental income is less than the costs associated with the property, such as mortgage interest, repairs, maintenance, insurance, council rates, and management fees, your investment is considered as negatively geared. In short, you are experiencing a financial loss on the property.
If you expect your investment property to make a loss, you can apply for a PAYG (Pay As You Go) Withholding Variation from the Australian Tax Office (ATO). This allows your employer to take out less tax from your salary and give you more money each pay period.
Negative gearing calculation in just 3 steps
Calculating negative gearing involves determining whether your investment property generates a loss, which can be deducted from your other income. Here's how to do it:
Step 1: Total your property incomeBegin by determining the total rental income you have received from your investment property over the financial year. To do this accurately, follow these steps:
- Weekly rent calculation: Identify the amount of rent you charge every week. For example, if your tenants pay $500 weekly, this is your weekly rental income.
- Annual calculation: Multiply the weekly rent by the number of weeks in the year. Typically, this is 52 weeks. So, if the weekly rent is $500, the total annual rental income would be $500 52= $26,000.
You can claim immediate deductions for specific expenses in the same year you incur them as long as your property is rented or available for rent. To qualify, ensure you:
- Personally incur the cost (no deductions if tenants or others pay).
- Maintain thorough records to substantiate your claims if asked.
Certain rental expenses, like capital works and borrowing expenses, must be spread over multiple years. Examples of costs eligible for immediate deduction include the following:
- Advertising for tenants: Costs for advertising to attract tenants.
- Body corporate administrative fund fees and charges: Fees and charges paid to the body corporate or strata for managing the property and maintaining common areas.
- Council rates, water charges, land tax: To local government and utilities.
- Cleaning, gardening, and lawn mowing: For maintaining the property's cleanliness and outdoor areas.
- Pest control: Expenses for managing pest infestations.
- Insurance: For building, contents, public liability, and loss of rent insurance.
- Interest expenses: On loans taken out for purchasing or maintaining the rental property.
- Expenses: Paid in advance, such as insurance premiums.
- Property agent's fees and commission: Fees paid to property managers or real estate agents.
- Repairs and maintenance: Incurred to keep the property in good, rentable condition and to fix any wear and tear that arises from renting out the property.
- Legal expenses: Legal fees related to property management, such as evicting a tenant or taking court action for loss of rental income.
Depreciation refers to the decline in the value of the building and specific assets within the property over time. You can claim depreciation expenses on your investment property for items such as:
Building depreciation costs:
For rental properties no older than 40 years, you can claim building depreciation at 2.5% per year. For example, if your rental property costs $500,000 to build, you can claim $12,500 as a depreciation expense each year for up to 40 years.
Capital work deductions:
Construction or renovation costs can be claimed as tax deductions over several years, not immediately. Similar to building depreciation, you can claim 2.5% of these costs annually for up to 40 years.
Plant and equipment depreciation:
Certain items within your property that wear out over time can also be depreciated. These include removable items over $300 that are not permanently attached and likely need replacement within a short period. Examples include:
- Carpet
- Light fittings
- Window fittings
- Showers
- Air conditioning units
- Hot water systems
- Stovetops and ovens
- Heat pumps
- Floating timber flooring
- Cupboards
- Furniture
These assets must be purchased new, not second-hand, and installed within six months of the newly built or substantially renovated property.
Negative gearing calculation example
Let's understand the negative gearing calculation steps discussed above with an example: This will help you to understand better how negative gearing works in a real-life situation.
- Alex owns a one-bedroom apartment in Brisbane, which he rents out for $500 a week, meaning his tenant pays $26,000 in rent per year.
- He pays council rates, insurance, and a property manager to handle tenant-related tasks, adding up to $6,000 per year in extra expenses.
- His investment loan costs $22,000 per year, so it costs him $28,000 per year to own his investment.
- As he receives $26,000 per year in rent, his investment results in a net loss of $2,000.
- Alex can claim this amount as a deduction from his income, which means he has less income to pay tax on.
If Alex normally earns $120,000 a year, he would be liable to pay $29,467 in tax in Australia. However, if his negatively geared property costs him $2,000 per year to own, this would reduce his overall income to $118,000 a year, meaning that he would pay $28,237 in tax, saving him $1,230 a year.
In addition to reducing the amount of tax Alex pays, he will also own an asset that will likely increase in value over the years. So, not only is he saving tax, but he is also growing his overall net assets.
While Alex benefits from immediate tax savings, he must also be prepared for the ongoing financial commitment that comes with a negatively geared property. This includes the possibility of property value fluctuations, which could impact the long-term financial outcome of his investment. Understanding the advantages and potential drawbacks of negative gearing helps investors like Alex make more informed decisions and develop strategies to manage their investments effectively.
Need more guidance on negative gearing?
Our experts can provide personalised advice to help you understand and manage its complexities effectively.
Are you eligible for PAYG withholding variation?
Wondering if you qualify for a PAYG withholding variation? If our negative gearing calculator shows significant tax savings on your rental property, you may be eligible. Contact us today for assistance with your PAYG withholding variation application.
At ZedPlus, we are dedicated to helping you navigate the complexities of property investment and maximise your tax benefits. With our guidance and resources, you can gain a clearer understanding of whether negative gearing is a good investment strategy for your specific investment goals and financial situation.
Wrap up!
Understanding and calculating negative gearing can seem complex, but breaking it down into three manageable steps—totaling your property income, deducting your property expenses, and accounting for depreciation—makes it more accessible. This process helps you determine the financial impact of your investment property and leverage tax benefits effectively.
At ZedPlus our loan specialists help you find the ideal investment loan by comparing top products from more than 40 lenders. Also, as an experienced tax agent, we provide comprehensive tax return filing services and expert advice on the tax savings implications of negative gearing. Trust our specialists to accurately calculate the cost and benefits of owning a negatively geared property. Contact us to learn more about our services.