What is negative gearing?

In the early 1980’s, the Australian Government realised that with a growing population, and people not in a position to purchase their own homes, this was placing undue pressure on the Government of the day to provide public housing causing exorbitant infrastructure and administration costs. When the Government introduced ‘negative gearing’, this encouraged taxpayers to purchase investment properties hence creating greater availability and choice of housing whilst stimulating the building and construction sectors.

Negative gearing describes the situation where you borrow to buy and investment (generally property or shares) and the interest and other costs you incur to maintain the investment exceed the annual income received from the investment hence the term ‘negative gearing’.

This negative result maybe a tax deductible loss and offset against other taxable income.

In property market terms, a negatively geared property is where the interest costs on borrowings and expenses to maintain the property (including depreciable assets and building write-offs) exceed the annual rental income. Overtime, the aim for the investor is to build a positive investment portfolio (where annual income exceeds outgoings) that grow in value at a higher rate than inflation.

When deciding on purchasing an investment property, the following are factors that need to be considered:

• Buying the right property in the right location is the key to capital growth.
• The old adage of ‘time in the market’ and not ‘timing the market’ is what counts. Experts suggest that the best property to buy is the property that you can afford at the time, not based on market trends.
• Negative gearing is just that…a negative or a loss, that maybe offset against your other taxable income. Gaining a tax benefit should not be the focus of any investment decision but a carefully considered position to accept in the short to medium term with the view of capital growth exceeding this over time.
• A decision on who should be the owner of the property. Whilst negative gearing may provide a taxation benefit for the owner of the property, such issues like asset protection, estate planning and capital gains tax (if the property is disposed of) need careful consideration.

How does it work?

The best way to illustrate how negative gearing works is to provide an example.

Based on the following:-

• Taxpayer A and Taxpayer B buy a property in joint names on 1^st January 2008 and sign the contracts with a settlement date of 1^st July 2008. The purchase price is $650,000.00
• As an investment property, the amount financed is 100% including costs:

Property                  $ 650,000.00

Stamp Duty             $    34,070.00

Loan Fees                $           600.00

Conveyancing       $            500.00

Legal Costs             $            500.00

Land transfer        $         1,350.00

Mortgage Reg.      $                98.00

TOTAL                        $ 687,118.00**

 **  The costings are for illustration purposes only and should not be considered accurate under any circumstances!

• The mortgage loan is calculated at 7.25%, interest only.
• The rental return is 5% of the cost of the property being $32,500 per annum.
• Depreciable items (fixtures and fittings) in the property are $25,000 and a depreciation rate of 15% (as an average) is applied.
• The purchaser’s engage a quantity surveyor who certifies the building construction was completed on 1^st of July 2001 at a cost of $350,000. Over the following 35 years an annual building write off deduction of $8,750.00 applies.

Year 1 – Rental Profit and Loss Statement

Gross Rent Rec’d (based on 52 weeks rental)                                                                                                            $  32,500.00

Less: Expenditure:

Agents Commission (5.5% of Rent + GST)                  $    2,110.00

Bank charges and fees                                                         $        120.00

Borrowing Costs $698 over 5 years                             $        140.00

Building Construction Write Off                                     $    8,750.00

Depreciation $25,000  x $15%                                      $    3,750.00

Insurance                                                                                $     1,500.00

Interest on Loan $687,118 x 7.25%                            $   49,817.00

Rates – Water and Council                                               $     1,700.00

Repairs and Maintenance                                                 $         525.00

TOTAL EXPENDITURE                                             $  68,412.00

TAXABLE LOSS TO BE OFFSET AGAINST

OTHER INCOME $ 35,912.00

Half Share as Property in Joint Names $ 17,956.00

Tax Benefit of $17,956.00 tax loss at 2008/09 tax rates:

Taxable Income                                    Tax Rate                        Tax Benefit

< $6,000.00                                            0                                 0

$6,001-$34,000                               16.5c                         2963

$34,001 – $80,000                            31.5c                         5656

$80,001-$180,000                         41.5c                         7452

$180,000+                                       46.5c                         8350