Negative gearing can be a confusing topic; investors seem to love it, Bill Shorten seems to hate it, banks are keen on it, while the Australian Tax Office is constantly claiming it is being rorted. So, what exactly is negative gearing and why is it talked about so often.
Let’s start by breaking it down. Gearing simply means borrowing money to invest. This could be to buy an investment property, shares, managed funds, or business interests. The negative part basically refers to whether the expenses incurred are more than the income generated by the investment. Depending on the investment, expense items may include interest payments, fees, brokerage, depreciation, management costs, rates, insurance etc, while income items are the rent, dividends, interest or distributions received.
Negative gearing is where the expenses incurred are more than the income generated. Paying out more than you are receiving, why is that a good thing? Well the additional expenses on the investment can be deducted against your other income, which can be great if you are on a high marginal tax rate.
Let’s look at Malcom for a simple example. Malcom’ s marginal tax rate is 37% and he has bought a rental property. The annual income on the property is $15,000, but the annual expenses, including interest on the loan etc, are $18,000. As Malcom has a $3,000 loss for the year, he can deduct this $3,000 from his other income, and obtain an $1,100 tax refund ($3,000 x 37%). This sounds great, but Malcom has still lost a net $1,900 for the year, which is not so great. So where is the advantage in this?
If Malcom held the property for ten years with the same average loss per annum, he would lose $19,000 on the property in this time. Malcom, however, was diligent and has done his research and bought in a growing area, so the value of his investment property has increase $190,000, giving him a net gain over the ten years of $171,000 ($190,000 capital gain – $19,000 expense loss). Had Malcom’s property lost value in this time, this would have compounded his losses even further, with potentially devastating consequences.
This simple example shows how this strategy can work, but it is not suitable for everyone. Careful investment selection, gearing setup and cashflow analysis are required to turn negative gearing into a positive outcome. If you would like to discuss potential negative gearing options or would like to further understand these strategies, give the team at Steve May Financial Services a call and start the conversation today.
You need to consider with your financial planner (or adviser), your objectives, financial situation and your particular needs prior to making an investment decision. Sensibly Pty Ltd and its authorised representatives (or credit representatives) do not accept liability for any errors or omissions of information supplied on this website
Nick Shanley, Steve May, Luke Styles and Shanley Financial Planning T/A Steve May Financial Services are Authorised Representatives / Corporate Authorised Representative of Sensibly Pty Ltd, AFSL 533923. Please refer to our website at www.stevemayfs.com.au to reference our Financial Services Guides.
