Discover how owning a rental property that costs more to maintain than it earns can save you money on taxes. This is known as negative gearing, and it allows you to offset any losses against your other sources of income, such as your salary. Keep reading to learn more about this tax-saving strategy.
Understanding negative gearing and how it works
Are you unsure about the term "gearing" when it comes to property investment? Let us explain it to you in simple terms. Essentially, negative gearing is when you borrow money to invest in a property, and that property is considered "geared." Negative gearing occurs when the expenses associated with owning a rental property outweigh the income it generates. In other words, if you're not earning enough rent to cover the costs of owning the property, you're in a negative gearing situation.
What is the difference between negative and positively geared property
If you're interested in property investing, chances are you've heard the term 'negative gearing' before. But what does it actually mean? In simple terms, 'gearing' refers to borrowing money to purchase an asset. This means that if you take out a loan to buy a rental property, your investment is considered 'geared'. Many investors choose to use some form of gearing, such as a mortgage, to finance their rental property. However, all of these terms can be overwhelming and confusing. Let's break it down and see what it really means for your investment strategy.
How does negative gearing work?
Negative gearing happens when the expenses associated with owning a rental property exceed the rental income it generates. This results in a taxable loss, which can usually be used to offset other sources of income, such as your salary or wage, to reduce your overall tax bill and provide tax savings.
Is owning a negatively geared property beneficial?
Let's say Bill owns a rental property in Australia that brings in $25,000 in rent each year, but costs $30,000 in holding expenses including mortgage interest. This creates a taxable loss of $5,000, which can be used to reduce the tax payable on Bill's salary.
If you know beforehand that your investment will result in a loss over the financial year, you can apply for a PAYG Withholding Variation from the Tax Office to decrease the amount of tax deducted from your salary. This can improve your personal cash flow, and your mortgage broker and tax adviser can help you explore your options in more detail.
While negative gearing can be advantageous, it's not without risks. When you negatively gear your property, you still record a loss. It's important to consider the consequences before committing to negatively gearing your investment property or properties. For example, what happens if you struggle to find tenants or if property values decline sharply? What if interest rates rise quickly, and you've agreed not to raise rents for a year? These are all important considerations that should not be taken lightly. Be sure to do your research and understand how you would cope if any of these scenarios come to pass.
If you're confident in your ability to handle any potential losses, negative gearing can be a viable strategy. However, it's crucial to take steps to minimise your risks. Consulting with financial experts and developing a solid investment strategy can help you make the most of your investment opportunities while mitigating any downsides.
Reducing the downsides of negative gearing
Selecting the Right Investment Property for You
Purchasing a property that is conveniently situated near key amenities and has broad appeal among potential tenants can go a long way in reducing vacancy periods for your investment property.
Effectively managing your finances for property investment
It's important to keep in mind that managing an investment property comes with certain costs, such as repair and maintenance expenses, as well as periods of vacancy. As such, before opting for negative gearing, it's crucial to ensure that you have sufficient income to cover all the expenses associated with owning a property, not just day-to-day costs. Be sure to factor in any potential unforeseen expenses as well.
Safeguard your investment and your family
As a property investor, it's crucial to prioritise adequate protection and insurance coverage not only for your property, but also for yourself in the event of unexpected circumstances. Being prepared for worst-case scenarios is always a smart move. If you're unsure about the types of insurances you need as a property investor, consider speaking with your mortgage broker or financial adviser.
Negative gearing an investment property is a significant decision that requires careful consideration. It's important to seek advice from a professional before making any commitments.
A mortgage broker can guide you through the entire process, help you identify and mitigate the risks associated with negative gearing, and assist you in formulating a plan to navigate any challenges you may encounter throughout your investment journey.
