Own an investment property?
Planning to buy an investment property?
Not sure how negative gearing works and how it can benefit you?
Then you must read this.
Negative gearing means that the interest you are paying on the investment loan is more than the income. As a result you are making a loss.
The Positives of Negative Gearing
So, if negative gearing means that you’re making a loss, how can that be positive?
Nobody wants to get into property investment to lose money. Even though most properties you buy will be negatively geared i.e. rental income is less than the interest repayments, the real benefit comes from the capital growth i.e. increased value of the property.
Negative gearing can work if the money you make from the capital growth is greater than the loss you make in rental shortfall. And with negative gearing, you will still reap the benefits of tax reduction by offsetting negative gearing amount against your other income.
John pays $20,000 in interest plus $5,000 for council rates, water rates and landlord insurance bringing his total cash expenses to $25,000. Assuming his rental income is $22,000, he is making a cash loss of $3,000 i.e. $25,000 – $22,000. And if we add property depreciation (non-cash expense) of $5,000 to the negative gearing amount, then total negative gearing amount comes to $8,000. This amount can be used to offset other income and subsequently reduce tax.
Assuming John’s income from salary is $60,000, he falls in marginal tax bracket of 34.5% including Medicare Levy. Offsetting $8,000 against his salary will bring down his taxable income to $52,000 and he pays tax on $52,000. Therefore, he ends up reducing tax liability by $2,760 i.e. $8,000 x 34.5%
If we further apply this tax savings to negative cash flow amount of $3,000, he is out of pocket by only $240 i.e. $3000 (negative cash flow) – $2,760 (tax savings) for the entire year. Therefore, he incurs only $20 per month out of pocket to hold this property and at the same time if property witnesses capital growth that’s an added bonus for John.
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