Peter Mulcahy
Public Accountant, Reg.Tax Agent
Professional National AccountantNegative gearing:
RP Data recently reported that the price gains for units were outpacing the price gains for houses, for the first time. Units values increased by an average of 13.5% while houses increased by an average 10.4% based on median house values. Trends are reported as being consistent across all capital cities. Tim Lawless from RP Data said "units were becoming more popular, partly because of price but also because they provide stronger rental returns, are closer to city centres, and often have good transport links." Average annual rental return for units is around 4.9% while houses average 4.1%.
Bridget Carter, "Weekend Australian", "The Nation", Jan 30-31 2010, p 8.
So what is Negative Gearing?
This occurs when you borrow money to acquire an income producing asset. The interest and other tax deductible costs in total exceed the income derived from the investment asset. Hence the returns are negative and the asset therefore has negative gearing.
Although negative gearing is commonly perceived as being associated with an investment property, the term also equally applies to investments in other income producing investments such as shares and managed funds. The gearing in the later cases is through "margin loans".
In Australia the investor hopes that capital growth will be greater than the costs involved in the investment. While this works well in a rising market, as many investors discovered in 2007, when the market corrects itself you can be badly 'burnt'. However, for many investors The attraction of borrowing or gearing to invest is that it enables you to invest in shares or property that might otherwise have been unaffordable. For individuals, the loss can also be offset against other assessable income and the tax benefit will depend on your marginal tax rate.
The Risks:
Make no mistake, it can be a risky business because while gearing can amplify your gains, it can also magnify your losses. There is no better example than the 2008 US sub-prime lending crisis where the collapse of the US Property Market left some 30% of mortgagees with a loan balance higher than the value of their property.
If you negatively gear property, you need to understand some important points:
- Properties are expected to generate profits only through capital gains and the gains need to be greater than the total losses incurred over the course of the holding period. Of course, there is no guarantee that the value of the property will appreciate, or at least appreciate enough to cover your losses.
- Investing in property requires planning and extra caution must be exercised when a property is projected to generate a negative cash flow. Tax benefits should not be the only reason for the property purchase.
- For taxation purposes, depreciation on the building could be tax deductible, however, the depreciation also reduces the 'cost base' of the property. The greater the depreciation you apply on your property, the lower the cost base value which may result in a larger taxable capital gain on sale.
- Negative Gearing isn't suitable for all investors. Although it can lower your tax liability, the tax implications will depend on your personal situation and the type of investment you choose. Negative Gearing implies a negative cash flow that you need to fund from other sources.
- You have to remember that your family home is a purchase from your heart while an investment property needs to be a purchase from your head. You've heard the old saying that the three most important things when buying a property are: 'location, location, location' and this is even more important when buying an investment property.
Case Study
Let's assume you buy a unit for $411,000 in your own name and borrow $329,000 to fund the purchase. The funds are borrowed at an interest rate of 8% and the weekly rent is $532 or $27,664 a year. Ongoing costs including agent's fees at 7% of the rent, rates, insurance, repairs and maintenance and other expenses are summarised below:
| Rental income = 52 weeks @ $532 | $ 27,664 | |
| Less: | ||
| Agents Commission = 7% of $27,664 | $ 1,936 | |
| Bank Charges | $ 72 | |
| Body Corporate Fees | $ 1,500 | |
| Council Rates | $ 1,365 | |
| Water Rates | $ 1,232 | |
| Insurance | $ 935 | |
| Interest = $329,000 @ 8% | $26,320 | |
| Repairs & Maintenance | $ 415 | $ 33,775 |
| Net Profit (Loss) for 12 months | ($ 6,111) |
After expenses, net income for the year will be $20,209 =(27,664 - 7,455), which is equivalent to a net rental yield of 4.92%. But after deducting the interest expense of $26,320 you actually lose $6,111 being ($27,664 - 33,775).
In the above example Paul and Maria, who earn $135,000 and $180,000 per year respectively, would achieve the following outcomes:
| Paul | Maria | |
| Annual Assessable Income: | $135,000 | $185,000 |
| Marginal tax rate (incl. Medicare levy): | 41.5 cents | 46.5 cents |
| Annual Tax saving due to the loss of $6,111: | $2,536 | $2,842 |
| Weekly amount of tax saved: | $48.77 | $54.65 |
| Net Loss after tax: | $3,575 | $3,269 |
| Weekly net loss after tax: | $68.75 | $62.87 |
How can we help you?
The benefits of negative gearing are best achieved through correct taxation advice combined with the best property and financing product. You should thoroughly assess whether the borrowing is within your budget, and whether the investment will provide taxation and capital growth benefits in the longer term.
When buying an investment property we can assist you in these areas:
- We have a comprehensive booklet on Negative Gearing that explores what you can
claim, what costs form part of the cost base for capital gains tax purposes and how negative
gearing works for tax purposes. The booklet is valued at $49, but we provide a complimentary copy to our clients at the conclusion of a negative gearing consultation.
- Evaluate the tax and cash flow consequences - Using an intelligent software tool we can prepare a 10 year cash flow analysis of the proposed property, taxable income forecasts and equity projections.
- Where to buy - through the services of a buyer's advocate we are able to help you locate the right property in the right location.
- We can arrange finance for you through a mortgage broker.
- The tax loss on the property can pose a major cash flow issue, however, we can prepare a PAYG variation application so that your regular pay packet reflects the annual tax saving.
Further suggested reading is in relation to our rental property services.
If you would like to know more, please contact our office today.
How you can help us
Keep excellent records for your investment property/ies.
As your accountants we are committed to helping you simplify your record keeping and aim to minimize your tax return preparation costs.
Rent Manager
If you own an investment property Rent Manager will keep all your rental property tax records in one place.
Historically we have found the calculation of capital gains on the sale of property to be a source of major headaches and frustration due to the loss of source documents. Rent Manager keeps your purchase and sale records for capital gains tax purposes plus all the information you need to prepare your annual tax returns. It also allows you to analyse potential investment property purchases through the 'property analysis' module.
Rent Manager includes the following features:
- Record the rental income and expenditure for your investment property
- Record information from the real estate agent monthly rental summaries
- Keep track of any mortgages including interest and bank charges
- Keep a log of your car travel for collecting rent and conducting property inspections
- The Annual Summary provides all the information for completing your annual tax return
- Keep records for multiple properties
- Calculate Depreciation of furniture & fittings
- Calculate Tax Deductible Building Allowances
- Record 'cost base' details and any loans to finance the property.
- Record property purchase, sale and improvement details so you don't get caught when you need this information for Capital Gains calculations
- Easy to follow manual and online help
- Print all the key reports that your accountant needs to complete your tax returns
- Full 90 day money back guarantee
Rent Manager is the perfect tool to manage your property, makes completing your tax returns easy and gives you peace of mind that you have the capital gains tax information you need when you finally come to sell the property. Copies are available from our office.
IMPORTANT DISCLAIMER:
Readers are advised that the purpose of this guide is to provide general introductory information. The information has been prepared in good faith and is for guidance only. It does not purport to contain all the information that would be relevant to any particular business opportunity. Further, the guide is provided to interested persons on the basis that they will be responsible for making their own assessment of that opportunity with the assistance of the information provided. The information in the guide should not be relied upon in substitution for professional advice and individual investigation.
Consequently Peter Mulcahy cannot accept liability for any loss occasioned, however caused, as he cannot take into account any specific individuals needs or other considerations. Parties considering any action or refraining from any action, on the basis of the contents of this web page, should first seek professional advice.
You see, small business is our passion!
We are Quality Assured by the National Institute of Accountants (NIA), which means you can be sure every project we undertake is carried out to International Standards, so that you can be guaranteed the precise result you pay for.
Last updated Friday 20th August 2010