What is Negative Gearing?
Negative gearing is a practice whereby an investor borrows money to acquire an income-producing investment property and expects the gross income generated by the investment, at least in the short term, to be less than the cost of owning and managing the investment, including depreciation and interest charged on the loan (but excluding capital repayments). The arrangement is a form of financial leverage. The investor may enter into such an arrangement and expect the tax benefits (if any) and the capital gain on the investment, when the investment is ultimately disposed of, to exceed the accumulated losses of holding the investment.
Tax treatment of negative gearing would be a factor that the investor would take into account in entering into the arrangement, which may generate additional benefits to the investor in the form of tax benefits if the loss on a negatively geared investment is tax-deductible against the investor’s other taxable income and if the capital gain on the sale is given a favourable tax treatment. Some countries, including Australia, Japan and New Zealand allow unrestricted use of negative gearing losses to offset income from other sources. Several other OECD countries, including the US, Germany, Sweden, and France, allow loss offsetting with some restrictions.
Here is a basic example of a negatively geared property:
*Amount owed to bank $400,000
Annual Interest rate @5.5% on $400,000 = $22,000 pa
Outgoing costs on property; rates, strata, management insurance, etc = $6000 pa
Total annual holding cost = $28,000 pa
Total annual income (rent) = 20,000 pa
Total Loss per annum = $8000
On a new property there could be depreciation on fixtures and fittings and building materials of around $12,000 in the first year. Depreciation is also a loss.
Total tax loss would be actual loss (8000) + depreciation loss (12,000) = $20,000 Tax Loss
Assuming you earn $100,000 per year, the last $20,000 is normally taxed at 37% + 2% Medicare = 39%. The last $20,000 (negative gearing loss) you earn is now tax free – giving you a tax saving of 39% x $20,000 = $7800
* Disclaimer: Please note that the figures and assumptions incorporated in this analysis are estimates for the purpose of illustration only. Whilst every care has been taken to reflect reality, all figures should be confirmed with a Tax Agent/Accountant prior to any investment decision.
