negative gearing

Whenever I discuss with friends or clients about "negative gearing" a rental property I am reminded how little people understand the term "negative gearing". So I've decided to re-visit it and give you an explanation of exactly what it is and how it works.

 "Negative gearing" is the technical term for "losing money".   If this surprises you then you better read on. To "negative gear" an investment means that the expenses are greater then the income which means there is a loss.

The best way to explain "negative gearing" is to use the following profit and loss statement with an assumption that the taxpayer is in the 30% tax bracket, as most Australians currently fall into:

Rental Income	$20,000
Less Deductions
Running expenses	-$5,000
Bank interest	-$25,000
Net Loss	-$5,000

So the first step in understanding the “negative gearing” strategy is the rental property must lose money – and in this example it has lost $5,000. At the end of the year this loss is included or claimed in the tax return and this is where most people get it wrong believing that they will get the full $5,000 refunded by the tax man. Not true!

The amount of the tax benefit a person will get depends on what tax bracket they are in. So if we assume that the tax bracket is 30% then the tax refund applicable to that loss will be $1,500 (i.e. 30% of $5,000). And as you can see this leaves the investor with a net loss of $3,500.

So basically, what has happened is that the investor has lost $5,000 to gain a tax refund of $1,500. At this point you may ask: so why do people get into “negative gearing”? There are tow reasons for this:

The first one, I believe, is most people just don’t understand it and they do it because they heard it from their friends and/or relatives.

The second reason why people get into “negative gearing” strategy is they are hoping that over period of time the value of the property will go up and once they sell it they will make their profit. That's in theory - however, what happens in the real world is another thing. And when you take into account the Capital Gains Tax that will apply when you sell the property - you can only question how good an investment a "negative gearing" is.

And the moral of the story?  DON'T get involved with “negative gearing” because you think or someone told you that "negative gearing" is a good tax deduction. Make sure you understand what it means......

If you have questions specific to your situation, feel free to call me or email me.