If you invest in property, it could be positively or negatively geared. And it has nothing to do with gears, cogs, or any mechanical intricacies.
So, what is gearing?
Gearing refers to whether the income you receive from a property is higher or lower than the overall amount you pay to own it. This can have significant implications for investors, not only for your week-to-week cash flow but also in terms of tax. Essentially, gearing is when you borrow money to make an investment. While this strategy can be used for any investment, it is most commonly applied to property.
Negative Gearing
If the rental returns from an investment property are less than the amount you pay in interest and other expenses, you can offset this loss against your other assessable income. This is known as negative gearing.
Positive Gearing
In contrast, positive gearing occurs when the income from your investment is greater than the outgoings, resulting in a profit. When this happens, you may be liable for tax on the net income you receive, but you could still come out ahead financially.
While negative gearing may prove tax effective, it’s dependent on the after-tax capital gain ultimately outstripping your accumulated losses.
The importance of capital gains
If your investment falls in value or doesn’t appreciate, then you will be out of pocket. Not only will you have lost money on the way through, but you won’t have made up that loss through a capital gain when you sell. That’s the key reason why you should never buy an investment property solely for tax breaks.
But if the investment does indeed grow in value, then as long as you have owned it for more than 12 months you will only be taxed on 50 per cent of any increase in value.
When it pays to think positive
If you are retired and have most of your money in superannuation, negative gearing may not be so attractive. This is because all monies in your super are tax-free on withdrawal. And thanks to the Seniors and Pensioners Tax Offset (SAPTO), you may also earn up to $32,279 as a single or $57,948 as a couple outside super before being subject to tax.
It makes more sense to negatively gear during your working years with the aim of being in positive territory by the time you retire so you can live off the income from your investment.
While buying the right property at a time of your life when you are working and paying reasonable amounts in tax may make negative gearing a good option, sometimes positive gearing may still be a better strategy.
Case Study
Two individuals with identical annual incomes of $70,000 each invest in a property valued at $400,000, bearing an interest rate of 6%. They face additional yearly expenses of $5000 while earning rental income of $500 per week.
Rod chooses negative gearing, financing the entire purchase amount, while Karen opts for positive gearing, securing a $100,000 loan. In terms of annual net income, Rod, despite negative gearing, fares worse than if he hadn’t invested at all, with a net income of $52,868.
On the other hand, Karen, with her positive gearing strategy, ends up $10,000 ahead, boasting a net income of $64,433 for the year. However, it’s worth noting that if Rod’s property appreciates in value over time, he may eventually recover some or all of the additional expenses incurred.
Claiming expenses
If you do negatively gear, then it’s important that you claim everything that’s allowed and keep accurate records.
For investment property, this includes advertising for tenants, body corporate fees, gardening and lawn moving, pest control and insurance along with your interest payments.
Ready to explore whether negative gearing is the right strategy for your financial goals? Don’t hesitate to give us a call. Speak to our team of wealth and property experts today.
* The information contained in this webpage is general in nature and has been provided in good faith, without taking into account your personal circumstances. While all reasonable care has been taken to ensure that the information is accurate and opinions fair and reasonable, no warranties in this regard are provided.
