Most Australian property investors buy real estate with the goal of making money, whether that’s through capital growth or rental income that boosts your cashflow each month.
But if you take a look at the Australian Taxation Office’s most recent statistics, you’ll find the majority (59%) of taxpayers who own at least one rental property actually declared a net loss in the 2018/19 financial year. What’s going on?
While making a loss on a property may not sound like a sound investment strategy, welcome to the world of negative gearing.
So what is negative gearing?
Gearing is when you borrow money to invest, such as taking out a home loan for a property purchase.
An investment property is said to be:
- Negatively geared – when the rental income from the property is less than your ongoing property-related expenses (i.e. you have negative cashflow)
- Positively geared – when the rental income is higher than the property-related expenses (i.e. you have positive cashflow)
- Neutrally geared – when the rental income is equal to your ongoing expenses (i.e. you break even)
So if negative gearing means the money coming in is less than the money going out, why would anyone make this kind of investment in real estate?
Two reasons.
Firstly, Australian property prices have historically risen in value over the long-term. So investors calculate that the property’s long-term capital gain will well and truly exceed any short-term deficit in its day-to-day holding costs.
Secondly, the ATO lets you offset the losses from a negatively geared property against your income, including your wage or salary. As a result, you pay less tax overall.
Let’s imagine that you own a rental property generating $20,000 in rent each year. However, the costs of holding the property, including mortgage interest, come to $25,000. This gives you a taxable loss of $5,000 which can be deducted from your income.
A loss is still a loss
As with any investment strategy, negative gearing comes with risks.
After all, your investment is still making a cashflow loss, regardless of the generous tax breaks. As a result, you will need to find the money to cover the difference. If you can’t, you risk losing the property.
Furthermore, keep in mind that high capital growth is not guaranteed. So, there’s a chance your property might not rise in value as much as you hope. The best way of avoiding this risk is to do your research and buy a quality property in the right location.
Please note that this is general advice only. Speak to a tax professional to see what sort of tax deductions would apply to your personal situation.
Want to buy a high-quality investment property? Buyer’s agent Ryan Goodinson can help. Book a free 45-minute strategy session by calling Ryan on 0419 000 794 or emailing ryan@insightfulproperty.com.au