Recently, negative gearing has been making waves in the news and with rental affordability becoming a serious issue in Australia, various political parties have weighed in.
However, there are concerns that any reforms to this widely used tax concession might reduce the supply of homes for renters by making housing investment less attractive.
And while there are certainly arguments for and against tinkering with this tax law, a further consideration that is contributing to debate, is the increase in gearing claims over the last few years.
Some $8.7 billion in negative gearing claims were made in the 2020/21 financial year, according to the latest Treasury analysis, and this is anticipated to soar due to the change from record low interest rates to a climate of higher rates in record time.i
Despite increases in rents, rental payments are still lagging behind loan repayments on properties that may have been bought at recent high prices, so the number of investment property owners who are negatively geared has increased.ii
To understand what all this means, it’s helpful to look at what negative gearing is and how it works.
What is negative gearing?
Negative gearing is an investment and tax minimisation strategy, primarily associated with property, where the costs of owning an investment property exceed the income it generates. This might sound like a strange way to invest, but it can be quite beneficial when you know how to play the game.
In simple terms, if you’re losing money on your property each year, that loss can be used to reduce your overall taxable income. For example, if you’re paying more in mortgage repayments, maintenance, and other expenses than you’re earning in rent, you can declare that loss on your tax return. This can lead to a smaller tax bill, which is appealing for many investors.
How does it work?
Let’s break it down with a quick example. Imagine you’ve bought an investment property for $600,000. Your annual expenses, which may include mortgage repayments, repairs, insurance, and property management fees, total around $40,000. If you’re only earning $30,000 from rent, you’re facing a loss of $10,000.
By declaring that $10,000 loss on your tax return, you can reduce your overall taxable income. If your regular job pays you, say, $80,000 a year, you can effectively lower this amount by $10,000, which means you’ll pay less tax overall.
The potential upside
So, why would anyone want to invest in a property that’s losing money even if it means you get a bit of a tax break? The key here is capital growth. While you may be negatively geared in the short term, many investors bank on the property appreciating over time.
Let’s say over time that property you bought for $600,000 rises in value to $800,000. When you eventually sell it, you could make a tidy profit, far exceeding the losses you incurred along the way. Historically, property in Australia has appreciated in value over the long term, making it a popular investment choice.
Risks and challenges
While there are some certain benefits associated with negative gearing, investing in property isn’t without its challenges.
Property investment requires a substantial initial outlay, not to mention the ongoing costs such as maintenance, rates, and insurance. Investors considering this type of arrangement need to have the financial stability to fund the shortfall out of pocket until the property becomes positively geared (meaning your investment property rental return is higher than your repayments and other costs) or is sold.
Plus, the property market can be unpredictable. Prices can fluctuate based on a multitude of factors, including economic conditions, interest rates, and even local demand.
It’s worth noting that some proposed changes could affect the way negative gearing works, so staying informed is crucial for existing or potential property investors.
If investing in property is something you are interested in exploring, we are here to help you qualify for an investment loan that’s competitive. Contact our team here.
ii These Australians are most likely to negatively gear their properties | Australian Financial Review
