There is so much talk about Negative gearing and the tax benefits of negative gearing which I cover in my free E-book - The Complete Guide To Property Investment. After speaking to so many first time investors, I have realised that not many really now what negative gearing is and what are the benefits of negative gearing. Nor do they understand the difference between negative gearing, positive gearing and positive cash flow.
Negative gearing, is where the expenses incurred on the property investment are greater than the income (rent). This creates a loss. This loss can be applied against your taxable income to reduce the income tax that you pay.
For a simple example: an investment property gets $500pw in rental income which is $26,000 in one year. However, the expenses to keep the property are higher than that. Interest of $22,000, rates $2,500, Management cost $2,500, Insurance $2,000. totaling $29,000.
If you own this property, this $3,000 negative gearing loss can be applied against your taxable income. Then the ATO will give you back your negative gearing loss multiplied by your tax rate. For example. If you tax rate is 37%. $3,000 x 37% = $1,110
Therefore the net cost of your property is not $3,000 but only $1,890. (3,000 - 1,110)
This is an easy to understand example of a negatively geared property investment.
Now where this negative gearing stuff can get very exciting is when we can increase expenses for things we have not had to pay for.
That is correct! We can artificially increase expenses for negative gearing via tax loopholes and still get the tax back. These expenses are called "Non-cash" deductions. These "Non-cash" deductions come from deprecation.
This is the process of writing down the value of the property over time. (which is strange because the property is actually going up in value...)
For example. The average NEW property may provide you with $20,000 in depreciation per year. Therefore, you are able to increase the negative gearing loss and get back the tax on that. $20,000 x 37% = $7,400. Now, when depreciation is claimed on the same property in the previous example of how to calculate negative gearing the outcome changes dramatically. Rather than the property costing $1,890. If we include the tax back the property now makes a profit. $7,400 (tax back on depreciation) - $1,890 = $5,510.
Therefore this negatively geared property investment is now making a profit NOT a loss. It is negatively geared but cash flow positive. It is quite amazing and it is the negative gearing tax loophole many Australian property investors have used to create significant wealth.
There is one snag to this, tax laws and negative gearing changed a few years ago to only allow large depreciation benefits on new property and NOT second hand. This means the benefits of negative gearing a second hand property are greatly diminished.
Positive gearing is the opposite of negative gearing. Positive gearing is where the income from the property (rent) is greater than all of the expenses. Positive geared investments can still make use of tax deductions and depreciation.
I often get asked the questions as to what is best, negative gearing or positive gearing. The answer is that there is no "best". It is what relates to you and your circumstances. I do think it is important that an investor aims for cash flow positive investment property. Whether that is through negative gearing or positive gearing, it doesn't really matter. The big thing is that the property itself and is increasing in its capital value.
Labour's stance on negative gearing has evolved over time, with recent developments indicating a potential shift in policy. Here's an overview of the current situation:
In 2019, the Australian Labor Party took a policy to the federal election that proposed restricting negative gearing to newly-constructed houses only, while exempting all pre-existing negatively geared properties
However, after losing that election, Labor shelved this policy and has since been cautious about revisiting the issue.
Treasury Modelling: Recent reports suggest that the Treasury has begun work on options to scale back negative gearing and capital gains tax concessions. This has reignited the debate around potential reforms to these tax policies. Government Response: Prime Minister Anthony Albanese has neither confirmed nor denied these reports directly. He stated that the government "values" Treasury's advice and is comfortable with it considering a range of issues
Officially Undecided: As of now, Labor has not officially announced any new policy on negative gearing. The government maintains that its focus is on addressing housing supply through existing legislative proposals
Cautious Approach: Given the political sensitivity of the issue, Labor appears to be treading carefully. They are likely weighing the potential benefits of reform against the political risks, especially considering their 2019 election experience.
Housing Supply: Labor has emphasised that any changes would need to avoid damaging housing supply, which they consider a top priority
Electoral Impact: The government is likely considering the potential electoral risks and rewards of proposing changes to negative gearing
Economic Effects: Previous analyses by Treasury and the Grattan Institute estimated only modest effects on housing prices and rents from limiting negative gearing.
The Coalition has already signaled strong opposition to any changes, labeling potential reforms as "Labor's housing tax". They argue that changes could negatively impact "mum and dad investors" planning for retirement. In conclusion, while Labor is not currently committed to changing negative gearing policies, recent developments suggest they are exploring potential reforms. The government appears to be carefully considering the economic and political implications of any changes before making a definitive policy announcement on negative gearing.
Here is a negative gearing example. To calculate negative gearing on an investment property, follow these steps:
Calculate total rental income:
Determine the annual rental income from the negative gearing property. For example, if you charge $500 per week in rent, the annual rental income would be $500 x 52 = $26,000
Calculate total expenses:
Add up all the expenses associated with the property, including:
Mortgage interest
Property management fees
Council rates and taxes
Insurance
Repairs and maintenance
Depreciation
Determine the net loss:
Subtract the total expenses from the rental income. If the expenses exceed the income, the property is negatively geared
Let's use a simplified example of negative gearing:
Annual rental income: $26,000
Annual expenses: $28,000 (including $22,000 in mortgage interest and $6,000 in other costs)
Net loss = $26,000 - $28,000 = -$2,000 In this negative gearing example, the property is negatively geared by $2,000
The negative gearing amount can be deducted from your other taxable income, potentially reducing your overall tax liability. The exact tax benefit depends on your marginal tax rate. The higher income or marginal rate you have, the more lucrative negative gearing is.
Considerations
A property can use negative gearing to become cash flow positive. This is generally new properties that provide depreciation benefits
The strategy is more beneficial for high-income earners due to their higher marginal tax rates