Negative Gearing

Posted Sunday, 24 October 2010 at 16:21 by Michael Chan
Tagged: Wealth Creation | Investors
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Negative Gearing

Negative Gearing is a common term used by many investors , for some it's part of their financial strategies to have more then one negative geared home under their portfolio because of the tax advantages you claim at the end of the financial year. But having a negative geared investment doesn't work for everyone and it could make you worst off in the first few years, so read more before you jump the hot guns of the elite - property investors.

What is negative gearing?

Negative gearing occurs when you borrow to invest in an income producing asset ( for our purposes; A investment property) and the cost of borrowing exceeds the returns (income) from that asset.

Put simply, a common negative gearing example is when:

1. You borrow money from the bank to acquire an property ---- > $400,000

2. You receive rent of $300/week = $15,600 per year -------------> $15,600

3. The interest you pay for your loan ( note: interest only, not principle), and other cost; such as insurance, repairs, agent fee, rates and renovation --------->$25,600 

4. So with this investment property you made a lost of $10,000 ($15,000 - $25,600), thus reducing your taxable income by this amount, and hopefully taking your tax bracket to the next level down.

So what can you claim under negative gearing?

The list is endless! check with your tax professional. But the most common items are:

1. Interest on mortgage repayments
2. Bank related charges
3. Legal fee
4. Body corporate and strata fee
5. Insurance - home and landlord cover
6. Building and content depreciation
7. Cleaning cost
8. Council rates
9. Pest Control fee
10. Maintenance fee
11. Repairs
12. Property Agent management fee
13. Telephone and postage cost (related to the investment property)
14. Traveling expenses ( flights if interstate )
15. Water rates

Case Study

Name - Peter

Status-  Unit bought to be rented out as investment.

Purchase - $400,000 Unit in Parramatta NSW, Unit was built in 2007, 2 bedroom.

Rent after 6 month - rented out for $390/week

Mortgage - Had 10% deposit - borrowed $360,000 @ 6.76% - monthly repayment of $1,900

Assumption- 1st year:

• Strata and body corp - $2000
• council rate - $1500
• Interest on mortgage - $19,000
• Depreciation - $13,000
• other cost- insurance and repairs - $2000

Scenario 1 - Income- $60,000 a year - taxable income 30% ( bracket 2) - Tax payable - $11,500

So now the new taxable income is $60,000 -$17,200 =$42,800  - so tax payable - $6,330                  SAVING: $5,170 in tax

As you can see by buying this investment home peter was able to save over $5,000 in tax, so that's an extra $5,000 saved toward buying his next investment home.

It's worth while to note, the tax payable on the next tax bracket (over $80,000) is an extra $12,450 base tax PLUS extra 7% ( 30--->37%).

Imagine if peter received a pay raise of $90,000- with this strategy in place he would have been pushed back down to the lower tax bracket saving him thousands!!

Advantage

• Properties that are negative geared usually attract potential for high capital growth ( house )- else you wouldn't buy it!!
• Tax benefits -
• Ability to lower your taxable income bracket to the next level
• Hopefully you look forward to "tax time" due to the cheque refund at tax time.
• Usually Lower entrance level to enter the property market (units) - can borrow up to 90 % of property value, so only need 10% savings
• Depreciation of newer dwelling can be claimed up wards of  $10,000-$15,000 for the first few years 

Disadvantage

• Can set you quite a bit back  in your financial budget if property is negative geared to much.
• Requires good control of finance and record keeping
• Need proof for all transaction and dollar you can claiming back
• For some complex situation and property you will need a good accountant to claim the right amount back
• Depreciation report usually cost $400-$600 per property
• Depreciation is only effective for newer property
• Not available for residential purpose, must be investment properties

Negative Gearing as wealth creation tool?

This topic is covered in a lot of details in my previous blog titled "Negative Gearing- wealth creation". But in summary, usually property that are negative geared has the highest potential of capital gain (land value usually), so in effect you might be losing out in your weekly rent compared to your monthly mortgage repayment. But with the tax benefit and capital growth in the long run you should be better off.