Real Estate Investing - Negative Gearing
What is Negative Gearing? Making a Loss to Make Money?
Negative gearing refers to purchasing an investment property (usually rental residential property) where your expenses are more than the returns. Essentially, this means making a loss in the investment property.
Why would you do that?
Why is Negative Gearing Useful?
In the Australian context, the Australian Tax Office (ATO) allows you to offset the cost of owning and maintaining the investment property against your other income streams. Whether or not this works, is dependant on the structure of your income streams. Have a chat with your accountant if you are not sure.
How is Negative Gearing Done?
In property investment, negative gearing involves buying the right property where you effectively make a loss through renting it out, after all the costs and deductions are considered. It is an important strategy which all investors need to consider, at the right phase of your investment journey. This is a rather risky strategy.
Broadly, deductions and costs that can be claimed includes:
Legal fees on the property purchase, stamp duty, building and pest inspection costs;
Buyers agents fees;
Council rates, water rates, land tax and owners corporation fees;
Regular maintenance and cleaning costs;
Landlord and/or Building insurance;
Property Management fees, etc
Depending on your investment structure setup, you might be eligible for other offsets such as:
Other expenses linked to managing your property such as travel and communication
The Australian Taxation Office regularly updates the tax rulings, and these rules do change frequently. Have a chat with your tax accountant to understand your situation and if you are eligible for any of the above deductions.
Risks of Negative Gearing
If negative gearing is an effective method to optimise your tax obligations, why is it not for everyone?
If you are just starting out on your property investment journey, and you are aiming to accumulate properties quickly, negative gearing can SLOW you down.
The loss will be considered unfavourably when you apply for your next mortgage, and it will effectively reduce your borrowing capacity.
Why are investors using Negative Gearing?
If negative is bad, why is negative gearing still relevant in property investments?
In addition to the potential of tax savings, investors using negative gearing are usually hoping for future appreciation. With the right property in the right area, a negatively geared property usually turns positive the longer you own them. This typically means holding on to them for 5 to 8 years.
Other Risks of Negative Gearing
Getting a negatively geared is relatively easy. The majority of properties in the metropolitan Melbourne are negatively geared.
However, getting the right property is easier said than done.
Property market conditions can change suddenly, and it has been proven to change rather unexpectedly in recent years. When market conditions change, an investor can be left holding onto an asset that will usually affect his / her subsequent property investment plans.
Your income situation may change negatively. As negative gearing effectively reduce your income, you need to ensure your income streams are consistent, which can be difficult in modern days. And having negatively geared properties in your portfolio is going to further exacerbate your financial stress.
You could be out of job the next day.
The lending criteria might change overnight, affecting your borrowing significantly.
The value of your property might crash overnight or it is not growing as quickly as expected.
Your business or income might have to stop if there is a social issue beyond your control, eg, a lock-down due to COVID-19 virus outbreak.
Other factors to consider when getting a negatively geared investment property:
High Entry Cost. You have to factor in property stamp duty (approx 5.5%, depending on state), legal, mortgage, building and pests inspections fees.
High Exit Cost. Real estate agent fees (approx 2%), sales conveyancing, property staging, etc.
Capital Gains Tax (CGT). If CGT applies to you, up to 50% of your profit from the sale will be included into your annual tax returns. Your accountant will be able to give you the appropriate advice for your circumstances.
In short, negatively geared properties can be a good way to optimise your tax returns, but, unlike a positively geared property, having negatively geared properties in your portfolio at the wrong time, is going to further exacerbate your financial stress. It could end up putting your investment property at risk.
For the right investor in Australia, we've helped investors purchase the right negatively geared property for their property investment plan.
Get in touch if you're keen to find out more.