Is negative gearing a good thing?

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    In Australia, using negative gearing as an investing strategy is quite popular. But does negative gearing make sense? When is negative gearing beneficial and when is it detrimental?

    These topics will be covered today so you can decide if negative gearing is the best financial approach for you.

    It's crucial to try to offer some balance given the current intensity of the negative gearing issue. Is it a positive or negative thing?

    Therefore, I'll provide five reasons why I believe it will be good for the economy. Of course, I must disclose my conflict of interest because I too am a real estate investor.

    It might be assumed that this is all self-interested because I run a firm where I assist others in entering the real estate investment market.

    So maybe we can present a fair perspective on why I believe it's actually a good thing, and my first justification is very straightforward. Negative gearing isn't reserved for the really wealthy, in my opinion.

    Undoubtedly, someone with a greater salary who pays a higher tax rate benefits more financially from it.

    However, just because I see many property investors doesn't indicate that middle-class Australians aren't attempting to fund their own retirement via this strategy.

    I see a diverse group of people interested in moving up the economic ladder, from high earners to those with medium to sort of low incomes.

    It would therefore seem from that cross-section that it is not solely for the really wealthy. Australians on the average desire to advance as well, and this is a great tool for them to do so. They seem secure and are less volatile than other investing choices.

    The fact that they put the most of their store wealth in their primary dwelling and that they feel like they really know it since the Great Australian Dream is so deeply ingrained in Australian culture merely further supports their sense of security and familiarity with investment property.

    What is Negative Gearing?

    It is best to go back to the beginning in order to comprehend negative gearing. Investors typically gear things either positively, negatively, or neutrally. Gearing is the term for borrowing money to make an investment.

    Positively geared properties are those where the rent you collect is greater than the interest and outgoings that must be paid. To put it another way, you are successful.

    Where your rent balances your interest and outgoings, you are said to be neutrally geared.

    In a situation known as negative gearing, you must make up the difference between your rental revenue and your spending costs from your salary or other sources of income in order to pay your debts and maintain your home.

    This is regarded as suffering a loss.

    The Benefits of Negative Gearing

    In other words, you don't pay taxes on losses, and if you use negative gearing, you might even be able to use those losses to reduce your income and lower your taxable income.

    Negative gearing may be advantageous for those paying a moderately high tax rate. Even improvements made to the property while it is being rented out, like a new kitchen or renovations, might be claimed on the decline in value.

    Other costs that you may deduct include:

    • Your borrowing costs –the administrative fees involved in opening a mortgage
    • Interest payments – many investors select interest-only loans since only interest repayments, not principal repayments, are tax deductible.
    • Rates – Council and water rates
    • Repairs and Maintenance – includes repairs done while the property is rented out as well as pest inspections.
    • Building and renovation construction costs – must be while renting the property or renting it out.
    • Insurances – Landlords insurance on the property
    • Body Corporate and Strata fees – for units, apartments or townhouses
    • Bank Fees
    • Land tax
    • Property management fees

    Who benefits most from Negative Gearing?

    Investors with a higher tax rate who stand to gain the most from tax deductions should use negative gearing (which are calculated on your marginal tax rate).

    The advantage increases with your tax rate.

    For people who ultimately wish to generate a capital gain (a profit when they sell) rather than rental yield, negative gearing is also a good option (income from renting your property).

    Positive gearing is better suited for low-income individuals or those looking to generate money through rentals.


    A loss on paper but cash flow positive. How does that work?

    The holy grail of real estate investing is achieving a fictitious loss but a genuine gain. You must be familiar with all the tax-deductible depreciation allowances in order to achieve it, or you must have a financial advisor who is.

    The depreciation allowances are based on the diminishing worth of new products year over year and are capped at a certain time period, thus the newer your property is, the better they are.

    Although they don't actually cost you anything, the decrease in value on paper can significantly alter your tax return.

    If your investment property costs $15,000 to maintain but only generates $10,000 in rent, your yearly profit would be $5,000.

    Offsetting your loss against your income would result in a benefit of $2,350 under a tax rate of 47%, but only $950 with a tax rate of 19%.

    The benefits for the investor in the higher tax bracket increase to $6,110 compared to only $2,470 for the investor in the lower tax bracket if you include depreciation costs, which are simply the declining value of new fixtures and not a tangible cost, of $8,000 on a new property. This brings your total losses to $13,000.

    When depreciation is taken into account, the higher-earning person actually comes out ahead by $1,110, whereas the lower-earning person is still $2,530 behind after the initial $5,000 tangible loss.

    It can be confusing, but it is worth talking to a financial consultant to see whether investing in real estate would be the appropriate choice for you if you have a high tax rate and want to see a long-term capital gain on your investment.

    What are the investment expenses that you can claim as a deduction?

    In general, you are able to deduct costs incurred for the upkeep and management of an investment property, including interest payments made on loans.

    You could be able to deduct the full cost of rental charges from your rental and other income, such as your salary and wages, if your asset is negatively geared.

    Depending on your situation, you might also be able to deduct depreciation from the rental income from the property. Property investors typically qualify for deductions in three primary categories:

    • Revenue deductions. You can deduct certain expenses from your income, such as recurring maintenance fees and interest on loans you take out.
    • Capital items. Large items like a built-in dishwasher in a rental property are deductible over a number of years and are subject to depreciation over time.
    • Building allowances. In general, you are able to make claims for building allowances, such as those for building work or depreciation over time.

    You can find a comprehensive list of tax-deductible expenses on the ATO website.

    • Further deductible costs
    • Fees for body corporate
    • Charges related to borrowing (e.g. stamp duty charges on your loan)
    • The price of tenant advertisement
    • Insurance
    • Fees and fees that real estate agents charge
    • A land tax
    • Costs of maintenance and repairs
    • The loan interest you pay as well as any other bank fees
    • Janitorial services
    • Costs of gardening and mowing the lawn
    • The cost of pest control
    • Rates for council and water
    • Capital expenditures

    What are the risks involved with negative gearing?

    Negative gearing is a risky investing approach, just like any other.

    Before pursuing this technique, you should be completely informed of what negative gearing entails because borrowing money to finance an investment is risky in and of itself.

    Before committing to a negative gearing approach, think about the following risks:

    • What happens if you run out of cash?
    • What happens if you're unsuccessful in finding a tenant and the house sits empty for a long time?
    • What if the real estate market collapses, preventing you from realizing the monetary gain you had anticipated?
    • What happens if you are unable to pay back your loan?
    • What happens if tax regulations are altered and negative gearing is no longer as financially advantageous for your particular needs
    • However, there are steps you can take to minimise the risks associated with negative gearing.

    The greatest strategy to reduce your investment risk is to choose a property that is expected to appreciate in value after conducting extensive research and selecting it as your investment.

    Make sure your income is sufficient to pay your debts, maintain your investment property, and cover interest payments even in difficult situations. To make sure you make a wise financial decision, consult professionals like a financial planner, tax accountant, and mortgage broker.

    What place does negative gearing have in the Australian market?

    Australian investors have been using negative gearing as a common tactic for many years. But there is also some debate about it.

    The usual objections to negative gearing are as follows:

    • It promotes real estate investment and decreases the number of available homes for purchase (and increases prices)
    • Investors with a lot of assets benefit more than buyers, making the wealthy even wealthier.
    • It promotes dangerous investment

    The following are typical justifications for negative gearing:

    • For investors, many of whom are only on moderate means, it is a meager side benefit.
    • It promotes real estate investment and home development.
    • Eliminating it might increase rents (by increasing investor costs) and potentially depress real estate prices by reducing investment.

    It's a complex subject, and specialists who discuss negative gearing in the media frequently do so with the objectives of a certain constituency in mind. The fact that many Australians invest in real estate and that many of them also rent adds another layer of complexity to the situation.

    Why is negative gearing a bad policy?


    Owner-occupiers in front

    The majority of those who benefit from tax breaks on housing are owner-occupants.

    The Capital Gains Tax (CGT) exemptions on owner-occupied housing were valued at A$30 billion in the most recent tax spending statement, on par with concessional taxation of superannuation at A$30.25 billion.

    The Henry Review acknowledged that both of these tax expenditures could be justified because they raise people's retirement living levels.

    The main residence exemption from CGT, however, distorts the market because owner-occupiers invest more in their homes and divert money from more profitable ones in the hope of receiving tax-free capital gains.

    The CGT discount is advantageous to investors as well, but negative gearing offers a quicker payoff. Two of the fundamental guiding principles of our tax system's creation resulted in negative gearing.

    Muddying the waters

    First, expenses are subtracted from income for determining an activity's profit or loss. The income of a taxpayer for a year is calculated using a worldwide approach, which aggregates revenue from all sources. Losses from one business can therefore be used to lower the tax due on income from other sources in the absence of any special limits.

    According to the tax figures for the 2010–11 fiscal year, 2.5 million individual rental property schedules were filed, representing over A$30 billion in rental income for the year.

    A total of A$37.8 billion in deductions were made from this revenue, of which A$22 billion was loan interest. A additional A$1.8 billion was claimed as capital works deductions, which enables the capital cost of a building used to generate rental revenue to be written off.

    Negative gearing is advantageous for real estate investments over other investments without any particular bias in the tax system because the factors influencing that choice are external to the tax system.

    For instance, compared to other investment types, lenders might be more willing to lend a larger share of the real estate acquisition price. As a result, the purchase can be made with greater leverage, and the subsequent capital gain will yield a greater return on investment. This does, however, assume that the investor has the available funds to service the loan, typically from other sources.

    The role of CGT

    If the capital gain from the sale of the investment was fully taxed, negative gearing would be less desirable.

    Although negative gearing results in negative cash flow, it generates an annual tax benefit that would be lost if the capital was subject to capital gains tax at the time the property is sold.

    But because a reduction is taken into account when determining how much is included in taxable income, CGT is often only paid on half of the capital gain. As a result, there is an inequity because all mortgage interest is deducted in full at the time it is paid. However, the capital gain is only counted as income for half of it.

    All non-business investment income, including capital gains, should be subject to a 40% discount, according to the Henry Review's recommendation (Recommendation 14), and the amount of interest that can be claimed annually should be decreased in proportion.

    This would lessen the incentive to leverage off negative gearing deductions as well as the bias toward investments that create capital gains over income.

    First homeowners and renters miss out

    The debate of tax incentives noticeably excludes the segment of potential buyers who are most impacted by property costs.

    First-time homebuyers may find it difficult to save for a down payment if they don't receive a windfall from the sale of another property. They also lack access to tax deductions to help with interest payments.

    However, there are differing results from first-time homebuyer assistance. Even while it increases the deposit, the subsidy itself may cause inflation as vendor price expectations increase to account for it.

    The remaining group of tenants also has to pay higher rents as rental property owners try to recoup their initial investment.

    Rent increases between 1986 and 1988, when the Hawke Government banned negative gearing deductions, have been used as evidence that any modifications to negative gearing would lead to higher rents.

    But the data demonstrates that other factors actually raised demand in the Perth and Sydney markets during this time, therefore this is essentially refuted.

    All of the existing policies have an impact on demand, which raises housing costs as investors and wealthy owner-occupiers bid up the price of housing.

    A series of regulations is required to increase the supply of housing, such as the National Rental Affordability Scheme, which offers tax breaks for the construction of new homes.

    In the end, tax reform in respect to housing will necessitate some difficult choices for the government.

    The main residence CGT exemption and the ability to deduct investment losses from other income are the two things that need to be changed. Without widespread support, such reform cannot be successful, and neither the Labor Party nor the current Coalition Government have shown any interest in implementing these ideas.

    Would the removal of negative gearing change the way you charge?

    Any elimination of negative gearing will lead to landlords raising the rent on their properties, making the situation less bearable for many.

    Many homebuyers are able to fulfill their aspirations of owning a home thanks to negative gearing, therefore politicians who are thinking about changing it should examine these factors.

    Negative gearing may be eliminated, but we don't know for sure what would happen in that case, and it would be unjust to attribute supply-side issues to this system.

    Negative gearing simply means borrowing to invest, as when you take an investment loan, your property is 'geared'. 'Negative gearing' happens when the costs of owning a rental property exceed the rent returns you earn.

    The key benefit of negative gearing is that any net rental loss you incur during the financial year may be offset against other income you earn, such as your salary. This in turn reduces your taxable income and how much tax you have to pay.

    Negative gearing is ideal for investors seeking long-term capital gain. As a result, it is most suitable for young professionals who can afford to have capital tied up in a property portfolio for several years. The strategy is less suitable for investors seeking to supplement their regular income, such as retirees.

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