What is negative gearing?
If you are going to buy an investment property and have done some research on it, you might have heard about negative gearing and be excited that it can reduce your tax bill. Have no clue on how it works? Let Apple Accounting explain it to you.
When people borrow to invest, we call it "geared" or "gearing". It is usually being used when we are talking about the property investment.
If the rental income cannot cover the interest charges on the borrowed money and outgoings, it is negative gearing.
On the other hand, if the rental income is more than the interest expenses and outgoings, it is positive gearing.
Negative gearing is often used by high income earners to reduce the tax bill. For example, Jimmy is a sales manager earning taxable income of $150,000 in 2019. Without negative gearing, his income tax is $42,997. Now if he has a rental property which generated a loss of $20,000, his taxable income becomes $130,000, and the tax bill would be reduced by $7,400 to $35,597. $7,400 saved tax vs $20,000 rental loss, it seems mathematically unreasonable to save tax by being negative geared. But the beauty of negative gearing is that both the cash and non-cash expenses could contribute to the rental loss. The depreciation of a rental property itself is a typical non-cash expense. It is just a number on the books, not the money paid from the owner's pocket. So Jimmy's situation might be much better if his $20,000 loss includes the depreciation expense. Generally speaking, the newer the rental property is, the more depreciation expense the property owner can get. Actually, in a savvy property investor's mind, negative gearing is not the only reason for the property investment. They may have goals for being positively geared to improve the cash flow and borrowing power, or for capital gains in a long run which is far more than the accumulated loss due to being negatively geared.
If you choose the negative gearing strategy, you will need to have the financial stability to fund the shortfall out of pocket until the property is sold and the full profit can be reached. Having the home loan fully or partially on a fixed interest rate will make the budgeting much easier as the repayment is the same during the fixed term. An experienced mortgage broker can clarify on this.
If you want to know more about the negative gearing, or if this strategy is aligned with your personal circumstances, contact us today 1300 457 119 to get your FREE consultation.