The pros and cons of negative gearing
Negative gearing is again in the news as political and other interested parties debate the impact that this tax break is having on the issue of housing affordability.
Currently, around a million and a half Australians enjoy the benefits of negative gearing with the proponents saying that it helps people to invest in property as a means of wealth creation and those against it saying it’s propelling property prices sky high and alienating first-time buyers.
The debate is vigorous and there is clearly no simple answer. To help you make up your own mind let’s investigate the pros and cons of negative gearing.
Negative gearing is when the costs of an investment or interest you are paying on the loan exceed the investment income of the asset. In other words, it enables taxpayers to subtract any losses that they make on an investment from their taxable income.
If everything goes to plan, there is the upside potential for long-term capital growth where the returns will eventually outweigh the level of borrowing and the costs.
Another positive is that negative gearing enables the taxpayer to deduct the negative amount from their tax payable. It’s always best to get professional tax advice but as a general point, every dollar lost on an investment property can be claimed later against earnings.
With negatively geared properties, it’s possible to invest in property where there is a good potential for development (e.g. converting a single property into multiple properties or developing vacant land).
There is also potential for the purchase of properties using negative gearing that have a high level of depreciation, which translates into further tax breaks.
Negative gearing is also said to have been responsible for the provision of affordable rental housing for tenants, because it has enabled so many more property investors to enter the market.
A negatively geared investment can eventually become positively geared as rental rates increase at a faster rate than the interest on the loan.
It’s important to understand that for negative gearing to work, the taxpayer must have income in order to claim the tax benefit. In other words, money needs to be paid out of earnings every month in order to keep a negatively geared property running. That can have a negative impact on cash flow if a taxpayer doesn’t have sufficient income.
Negative gearing is an aid to investment and is only a sound strategy as long as the investment itself is sound. Negative gearing can encourage people to invest when they shouldn’t – and that’s not good news.
Some people argue that the tax break enabled by negative gearing has meant that investors are happy to pay inflated prices for some properties, which has pushed property out of reach of first-time home buyers.
In summary, negative gearing can be a good strategy if the money that you make from the capital growth of your investment is greater than the loss from rental shortfall.
At the end of the day, the aim of investing is to make money and it’s essential that you navigate your financial strategy carefully and cautiously – and on the basis of thorough research and understanding.
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Fairly balanced article. However a few points have been missed.
1. A negatively geared property is running a negative cash flow or in other words an investment running at a LOSS. This is regardless of the tax deduction they currently receive which only partly reduces that loss anyway. Many investors seeking negative geared properties fail to comprehend this important point.
2. Removing negative gearing takes absolutely nothing away from the investor. Investors can still claim 100% of their investment expenses. The only thing that changes is that the most that can be claimed in any one tax year. The becomes limited to the amount of income that investment produces. The rest of the expenses are rolled over into the next tax year as accumulated losses. i.e excess expenses get rolled over each year until a taxable event occurs such as when income exceeds expenses or when the property is finally sold. When this occurs the accumulated expense losses are offset against the profits made to reduce tax at that later date.
Thanks for the comment Chris, very good point.
Great article which is very helpful in making people decide if Negative Gearing is for them or not. One thing I would add or emphasize if that people have to make sure they are not paying too much for the property and are being dudded on price. If you pay too much for a property, ie more than it is worth, Negative Gearing is a waste of time because you will not make a profit.