What is Negative Gearing?
COVID-19 has provided a great metaphor for what ‘negative gearing’ means in human terms. Broadly speaking, it’s when what’s going out is greater than what’s coming in. For all of you who dropped to $0 income in the early weeks of COVID-19 – but with your expenses remaining exactly the same – you have a painfully real experience of what negative gearing feels like when it happens to a human, without the perks.
How does negative gearing work?
Where real estate is concerned however it’s a different proposition. As outlined above – the situation involves expenses being greater than income from an investment property. In the case of property or assets, that means the running costs, mortgage repayments and maintenance of your investment, exceed the income being generated from it. Need an example? Let’s say you borrowed money to invest in a rental property; negative gearing is in practice when the rental income you collect from your tenants (your income) is less than the costs of owning, managing and maintaining the property (your expenses). The outcome of that results in a loss to you, which can then be deducted against other income, such as salary and wages.
So, if you’re an Australian tax payer, you pay tax on the personal income that is left over, after you’ve deducted the costs or expenses related to generating that income. One person’s deductions will differ from the next, just as income sources are different from one person to another. The less personal income you have to declare, the better your tax bill will look. Allowing investors to offset their loss by way of saving overall on their tax bill, is how the Australian Tax Office supports private sector investment in rental housing in Australia. Historically speaking, private investment in housing has always led to better outcomes than public investment – need we remind you of the many Housing Commission tower blocks around Australia?
What can I include as a deduction and how do I make the calculations?
Adding up the expenses and costs related to owning and running your property, is the first step to calculating your deduction amount, for the purposes of your annual return. Knowing all the things that can be classed as a deduction is crucial – especially if you’re trying to get over the line to make sure your property is negatively geared. Expenses can range from interest payments, body corporate fees and land tax, to plumber’s bills, property management fees and painting supplies. There are also expenses that can be claimed immediately and some that are claimed over the long term, such as depreciation on the asset. A range of things can determine whether something is or isn’t an expense so it’s best to consult a tax depreciation accountant when you first start out with your investment property. Together you can go through the specifics of your property, the deductions that can be claimed for it and also draft a depreciation schedule that can be referred to annually when you are making your negative gearing calculations.
Once you’ve defined your deductions and your depreciation amounts (for the property plus other assets such as furniture and equipment) and have two solid figures, you can go on to make your calculations and see how much you’ll be able to deduct from your taxable income, come end of financial year. First, you need to add up all income amounts generated from your property or properties – which will be the rent you charge per week or month, multiplied by months or weeks for example if you charge $1,800 per month, you would multiply this by 12 (for the number of month/s payments per year) to get $21,600 which is your gross income from that property annually. From that figure, you deduct your annual expenses and your depreciation amount and ideally will have a negative number in that little window of your calculator. This amount is how much you can deduct from your annual taxable income.
Why does negative gearing pop up so often in the news?
Negative gearing is an effective vehicle for wealth creation, but many average Australian families are only focused on simply providing a home and lifestyle for their kids in the present day, with hope and or belief that retirement will take care of itself.
With negative gearing enabling those on moderate incomes to still able to dip their toes into the investment world. It’s also considered to be one of the key drivers to the sustained availability of rental properties in Australia and a stabilising factor where property prices are concerned. It can be a great strategy for rentvestors, or those first home buyers looking to buy now and building their wealth in their early years. As always, we recommend you consult your financial advisor or accountant to review your own personal circumstances and whether negative gearing is suitable for your circumstances and investment goals.