Introduction
Property investment is a powerful way to build wealth, yet many investors feel overwhelmed by the perceived complexities of managing a property portfolio. One common source of confusion is the "negative gearing" strategy, which involves owning an investment property where the costs exceed the rental income, resulting in a financial loss.
This loss can be used to reduce taxable income, which is why some investors find it appealing. According to the Australian Financial Review (June 8, 2021), 2.3 million Australians own rental properties; of these, 1.3 million are negatively geared by circumstance or choice. These figures underscore the prevalence of negative gearing and its significance in the investment landscape.
However, it's important to note that negative gearing is not always the best investment strategy for everyone. The suitability of this strategy depends on your circumstances, including your financial goals, tax position, and risk tolerance.
For some investors, positively gearing a property, where rental income exceeds the costs, might be more beneficial as it provides immediate positive cash flow. Evaluating your specific situation and long-term objectives is crucial in deciding whether negative gearing aligns with your investment goals in 2024. This article aims to provide insights and guidance to help you make an informed decision.
Why do some investors choose negative gearing despite initial losses?
Investing in property or shares intending to make a loss is counterintuitive. However, many investors do this, expecting the capital gain (the difference between the sale and purchase prices) will eventually outweigh the initial losses.
For example, an investor might purchase a property for $500,000 and rent it out, even if the rental income doesn’t cover the mortgage and other expenses, leading to an annual loss. They do this because they anticipate that the property’s value will appreciate significantly over time, perhaps selling it for $700,000, resulting in a substantial profit.
In some cases, investors may not plan to be in a loss position but find themselves there due to unforeseen circumstances. Higher-than-expected expenses, such as major repairs, or lower-than-anticipated returns, such as a temporary drop in rental income, can result in financial losses.
A significant advantage of this approach is the tax benefit associated with capital gains. When the asset is sold after being held for more than 12 months, only 50% of the capital gain is subject to income tax. This potential tax saving makes the strategy more appealing to many investors.
Beyond the tax implications, there are several non-tax reasons why people engage in negative gearing. Many investors strongly believe in the long-term value of real estate, often influenced by favourable market conditions and advice from property investment advisers. This belief, along with media promoting property investment benefits, drives the preference for real estate.
While negative gearing involves initial losses, the prospect of long-term gains, both financially and in terms of tax benefits, makes it an attractive strategy for many investors. Understanding the benefits and drawbacks of negative gearing is significant for making an informed decision.
How to calculate the tax implications of your negatively geared property?
Calculating the tax impact of a negatively geared property involves several steps. Firstly, tally up all income and expenses related to the property. This includes rental income and eligible expenses such as loan interest, maintenance, and property management fees.
Next, consider your overall taxable income, which determines your marginal tax rate. For the financial year 2024/25, personal income between $45,000 and $200,000 will be taxed at a flat 30% rate. Until then, tax brackets are more varied.
To determine the tax effect, follow these steps:
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Step 1: Calculate net rental loss:
Subtract your total rental expenses from your total rental income. For example, if your rental income is $20,000 and your expenses are $30,000, your net rental loss is $10,000.
Step 2: Adjust your taxable income:Deduct this net rental loss from your taxable income. If your taxable income before the rental loss is $100,000, it would be reduced to $90,000.
Step 3: Calculate tax savings:Multiply the net rental loss by your marginal tax rate to determine your tax savings. Using the 30% tax rate for the 2024/25 financial year, a $10,000 net rental loss would result in $3,000 in tax savings ($10,000 * 0.30).
Alternatively, you can use a negative gearing calculator by entering your income and investment property details. The calculator will automatically compute your tax implications and potential tax savings.
How to claim negative gearing on your tax return?
Claiming negative gearing on your tax return is straightforward. In the rental property section of your tax return, record all rental income and related expenses. Offset any loss against your other income, like your salary. If the loss exceeds your income, carry forward the surplus to future years. If negative gearing results in a tax refund, you might adjust your withholding rate by applying for a variation with the tax authority.
Need more guidance on negative gearing?
Our experts can provide personalised advice to help you understand and manage its complexities effectively.
Is negative gearing right for you?
Determining if negative gearing suits your situation depends on various factors unique to you. This strategy is generally favorable for investors focused on achieving long-term capital growth and who can commit their funds to property investment over several years. However, the increasing costs of living and rising mortgage expenses can put a significant strain on your monthly finances. If you are already on a tight budget, negative gearing may not be the best choice.
Individuals with stable, high incomes might find negative gearing beneficial, as they can handle the initial financial burden while targeting long-term profits. On the other hand, entrepreneurs who require liquidity for immediate business needs may find this strategy less advantageous since it locks up capital that could be used for other investments.
The tax advantages of negative gearing are more pronounced for those in higher income brackets. High-income earners, who are taxed at the highest marginal rates, can offset their rental losses against their taxable income, resulting in considerable tax savings. For example, a taxpayer in the 45% tax bracket gains more from these tax benefits than someone in the 19% bracket or not paying taxes. When you calculate negative gearing benefits, it's essential to consider how it impacts your overall financial strategy and tax liabilities.
If you would like to know more details on building a tax-efficient property portfolio with negative gearing, contact the tax planning specialists at ZedPlus. Whether you're new to property investment or an experienced investor, our team can help you maximise your investment benefits. Don’t pay more tax than you have to—contact us today to start optimising your financial strategy.
Tips for successful negative gearing property investment
- Choose a prime location: Select a property with strong tenant demand and proximity to amenities such as schools, shops, and public transport. This will help ensure your property remains attractive and reduce the risk of extended vacancies.
- Ensure financial readiness: Verify you have sufficient funds to cover all potential expenses, including mortgage payments, maintenance, and repairs, even during periods when the property is vacant. Proper budgeting will help you manage unexpected costs without financial strain.
- Acquire comprehensive insurance: Protect your investment with appropriate insurance for the property itself and additional coverage for personal liability and rental income protection. This safeguards against unforeseen events that could impact your financial stability.
- Evaluate investment over tax benefits: Focus on the property's investment potential rather than solely on the tax advantages of negative gearing. Ensure the property has strong growth prospects and the ability to generate positive returns in the long term.
- Seek properties with growth potential: Look for properties that promise reliable and rising rental income over time. Consider factors like local economic conditions, infrastructure developments, and future demand trends to gauge growth potential.
- Set realistic return expectations: Base your expectations on thorough research of similar properties in the area, considering rental yields and historical price trends. Understanding the local market will help you set achievable goals and avoid disappointment.
- Plan for the long term: Approach residential property investment with a long-term perspective, typically 5 to 10 years, to achieve your financial goals. Real estate investments often require time to appreciate in value and generate substantial returns.
- Avoid over-leveraging: Borrow within your means to maintain financial stability and avoid excessive debt. Ensure your loan repayments are manageable even if your income fluctuates or expenses increase.
- Prepare for interest rate fluctuations: Ensure you can manage higher repayments if interest rates increase by stress-testing your budget. This preparation will help you avoid financial hardship and potential forced sales during economic changes.
- Understand and manage risks: Be aware of potential risks, including economic downturns, environmental factors, and legislative changes, and plan accordingly. Diversify your investments and have contingency plans to mitigate these risks effectively.
Wrap up!
Negative gearing can be a valuable investment strategy for those seeking long-term capital growth and tax benefits. However, it requires careful consideration of personal financial circumstances, market conditions, and risk tolerance. By following the outlined tips and seeking professional advice from ZedPlus, investors can optimise their property investments for future success. Contact us today to start optimising your financial strategy.