Who benefits from negative gearing?

Negative gearing has a lot of benefits. One of the five strategies I want to share with you is to focus on high growth sectors.

There are several significant benefits to investing in real estate utilizing the negatively geared method, which is a popular one in Australia.

In this episode, I'll go over five benefits of negative gearing.

In comparison to other countries, Australia makes it significantly tougher to find positively geared properties. Why should you think about negative gearing as an investment strategy and what are some of its benefits?

Property investing involves a great deal of technical complexities, with negative gearing being one of the most hotly debated issues in the market.

It's crucial to comprehend the advantages as investors decide to keep their negatively geared properties due to their own long-term investment goals.

Key benefits of negative gearing property

A property that is negatively geared is one that is losing money. Many Australian real estate investors are experiencing poor returns on their investment properties as a result of the current COVID-19 outbreak due to a loss of rental income.

Although each person's financial situation is unique, the advantages of negative gearing assist investors in lowering their taxable income.

The choice of whether to keep a negatively geared property is a big financial one, it is vital to note.

Although everyone has a unique decision-making process and investment strategy, they all receive the same two main advantages.

To be able to make wise investment decisions, Australian property owners must have a firm understanding of the idea of gearing.

Gearing is the process of borrowing money to buy an asset, in this example, a property.

There are three types of gearing: Positive gearing occurs when the income exceeds the sum of the interest you are paying and other expenses, neutral gearing occurs when the income is equal to the overall expenses, and negative gearing occurs when the income is less than the total of the interest you are paying and other expenses.

When is losing money a good thing?

According to the information above, you should typically strive towards positive gearing. Who wants their assets to be more expensive than they are profitable, after all?

Australian real estate investors, meanwhile, have traditionally viewed negative gearing as advantageous.

The potential for capital growth is one of the main benefits of having a negatively geared property.

Property owners may be able to benefit from a long-term financial boost as the value of the negatively geared property increases, even while negative gearing provides for a short-term profit.

For instance, you would profit if you bought a negatively geared property and were able to sell it for more money than you paid for it initially plus the additional expenses.

Negative gearing also has the benefit of allowing you to offset your loss against other sources of income, most frequently your pay.

Your negatively geared property actually lowers your taxable income in this situation, so the costs of the property are now covered by rent, tax deductions, or perhaps other sources of excess cash flow or savings.

In order to estimate your investment's net income under specific conditions, utilize this negative gearing calculator.

What are the tax deductions you can take advantage of?

As previously indicated, there are three basic forms of tax deductions that can (and perhaps should) be obtained by the owner or property investor of a negative geared property.

The first kind consists of revenue deductions, which are taken out of a property investor's current year's income and include interest, maintenance charges, and ongoing expenses including bank and agent fees, advertising fees, cleaning costs, and insurance.

Capital items that are susceptible to depreciation are claims for deductible expenses, the second category.

The property investor must spread out the cost of this type of deduction rather than deducting it all at once.

Last but not least, investors may be eligible to deduct 2.5% of the cost of capital works for building and landscaping over a 40-year period.

An extra list of costs that you can and cannot claim has been helpfully provided by the Australian Taxation Office. Some things that you can't do? bills like water and electricity because your tenant is responsible for paying these.

You cannot deduct acquisition and disposal costs because they are part of the property's cost base and would reduce any capital gains tax due if you decide to sell the property in the future. Acquisition and disposal costs include the purchase price, legal fees, advertising costs, and stamp duty on title transfers.

What are the potential risks of negative gearing?

Negative gearing carries some dangers and consequences. Negative gearing a property would not be the greatest choice for real estate investors who do not have a sizable quantity of cash on hand. Consider the worst-case scenarios because, as you may recall, this tactic still results in a loss.

When your income is entirely based on capital gains, there is also the chance that you won't be able to profit should the market experience unexpected price drops.

In a similar vein, there is the risk of unexpected fluctuations in interest rates, which can make it challenging for you to increase the rent.

How can these risks be avoided?

You can take a variety of actions to reduce the dangers connected with negative gearing. You must make sure that you choose your property wisely, just like with many other investing choices.

Make sure the property you plan to invest in is in a prominent area, since this will guarantee a high demand for tenancy.

Additionally, you must have a large quantity of buffer money. This will cover unforeseen costs in the event that your property is damaged or becomes empty. You should consider your sources of income as well as your capacity to handle all of the expenses that property ownership implies.

Additionally essential to safeguarding yourself from the worst-case circumstances is insuring your home.

What about positive and neutral gearing?

As was already mentioned, a property is favorably geared when the rent it generates covers its ownership and management expenses.

The gains are subsequently taxed, and whatever is left over is your investment's net profit. Even though neutral gearing is a rare occurrence, many investors would regard a property as neutral if the profit or loss was negligible.

No benefit for negative gearing

Because their taxable income was so low, 25% of negatively-geared taxpayers did not benefit from negative gearing at all during the period. Instead, they did not pay any income tax.

Even though these taxpayers did not enjoy a tax benefit during that tax year, CPA Australia's head of external affairs Paul Drum notes that they may still profit from tax losses carried forward to subsequent tax years and from future capital gains tax benefits.

Who benefits from negative gearing is a contentious issue between the two major political parties.

The term "taxable income," according to critics, is misleading because deductions have already been made.

Negative gearing, according to the Australian Labor Party, is mostly utilized by the wealthy, sometimes to the point where they pay no taxes, and is driving up housing costs.

If elected, Labor promises to limit future negative gearing to newly constructed properties. All negative geared properties will be quarantined and unaffected by the policy if they exist before it takes effect.

Wright claims she and Bond conducted the research as a result of her frustration with politicians who promote the benefits of negative gearing without providing supporting data. She adds, "I always wonder when they don't back it up with statistics because then it doesn't support their case."

The study makes use of what is referred to as the ATO's "2 per cent file"—a file that contains the tax data of 2% of randomly chosen taxpayers, anonymized.

Researchers are able to undertake a more in-depth analysis using the data, which is from the 2013–2014 tax year and contains all of the information that filers included in their income tax returns.

Investors' property losses

Taxpayers were classified into three groups by the researchers: those who negatively gear, those who positively gear (i.e., whose rental properties yield a profit rather than a loss), and those who do not own an investment property.

A little more than 6% of taxpayers in the sample possessed positively geared property, compared to little under 10% who had negatively geared investments. Comparatively, a whopping 84% of respondents owned no investment property.

The greatest single source of federal tax revenue, income tax, which is collected from individual taxpayers, accounts for 47% of all federal tax revenue.

The authors state in the AAR report that "given the quantity of money that individual income tax raises, it is of enormous importance and interest to the Australian people and government."

The researchers estimate that negative gearing nationally reduces taxable income by around A$10.8 billion, although this is not the cost to revenue.

To determine how much extra tax each negative gear in the sample would be paying if they didn't utilize negative gearing, Bond and Wright used the individual data from the 2 percent file. Nationally extrapolated, the negative gearing of investment property cost the federal government $3.46 billion in tax revenue.

Expenses to claim

Investors can often deduct all costs associated with a property during the time that it is rented out or actually offered for rent.

These include current claims for revenue deductions or administration and maintenance costs, as well as deferred claims for borrowing costs, depreciation, and capital expenditures.

Renter advertising costs, body corporate fees and charges, council rates, water charges, land tax, cleaning, gardening and lawn mowing costs, pest control costs, insurance costs, interest expenses, real estate agent's fees and commission, repairs and maintenance costs, and some legal costs can all be immediately deducted.

On the other hand, costs like borrowing fees, the loss in value of deteriorating assets, and capital improvements may be written down over a number of tax years.

Investors will need to apportion costs and, in some circumstances, extend their deductions over multiple years to figure out the deductible amounts for properties offered for rent for only a portion of the year, properties not wholly used for rent, and properties rented at non-commercial rates.

Investors are not permitted to deduct costs that are not directly their own, such as renter-paid utilities like water and electricity. GST credits and acquisition and disposal charges are also not regarded as allowable deductions.

Isn't losing money a bad thing?

While the majority of beginning investors would naturally strive for positive gearing since they want to prevent any form of loss, some seasoned investors are aware that negative gearing has advantages as well.

One reason is that negatively geared homes typically have strong capital growth potential. Negatively geared properties are frequently guaranteed to generate significant returns within a typical market cycle, between seven and ten years, as long as the investor acquires in a place with strong fundamentals for future growth.

The gains from capital growth typically offset the losses sustained over time. The investor will ultimately get their money's worth if they sell the property at the opportune time, which is when its value exceeds its cost of acquisition and other expenses.

Investors can also deduct their losses from their income, such as their salary, earnings, and profits from their businesses.

In essence, the investor will have their property-related expenditures covered by their tenant through rental returns, by the Australian Taxation Office through tax savings, and by their surplus cash flow if they have enough cash flow and safety buffers to cover ongoing costs.

Additionally, negatively geared properties give buyers the chance to increase the value of their asset right away by remodeling, subdividing, or making other structural changes to the current structure.

Investors are strongly advised to conduct their own research and consult experts as necessary before making any significant investment decisions. This will help them better understand the wealth-creation strategies that will work best for them given their unique financial situation, objectives, and constraints.

Trends in negative gearing

Negatively geared real estate was used by 95,000 more people in 2016–17 than in 2010–11, although during the preceding seven years of data, the percentage of users has been fairly stable.

Over the past few years, less money has been written off due to negative gearing. Rental losses were $13.3 billion in 2010–11, but are currently only $11.5 billion.

Additionally, fewer people are deducting from negative gearing. In 2010–11, the average rental loss was $10,934, while in 2016–17, it was only $8771.

The most common age range for those who use negative gearing is between 45 and 60: In that age group, 14% of taxpayers reported a net rental loss.

In 2016–17, 19 individuals under the age of 18 reported net rental losses on their tax returns.

Purchase in More Predicable Areas

Regional hubs have a number of properties with positive cash flow.

The ability to buy real estate in places with greater stability and predictability is the third advantage of investing with negative gearing.

Regional hubs, rural places, mining towns, and other types of properties that aren't as popular to everyone are where you'll find a lot of positive cash flow properties.

But with negative gearing, you can simply go after regions like large capital cities where there is a lot of demand for housing and you can quickly target the houses that everyone in the area wants that are very desirable.

Leverage for Greater Returns

The fourth advantage of negative gearing is the possibility of leveraging against desired capital growth in order to increase returns and diversify your portfolio.

If the value of your home increases, you might be able to borrow against that increase to put a deposit down on another property and grow your portfolio without actually investing any additional money in these properties.

Opportunity to Add Value (Almost) Instantly

The chance to increase value very immediately through things like renovations or subdivisions or a lot of other ways to increase value to a property is benefit number five.

You may have the opportunity to raise value on a negative geared property by working hard and making it more desirable to your target market after obtaining it for a great price even though it may be rundown or have been on the market for a very long time.

As you can see, negative gearing is a very popular investment tactic and has a number of significant benefits.

I still adore positive cash flow properties, and I anticipate that I will for the rest of my life. Passive income, financial independence, and the ability to spend my time whatever I please are the things that matter most to me.