Your Success Club > Articles > Negative Gearing - What Does it Really Mean?
Negative Gearing - What Does it Really Mean?
By Yong-Long Lai
Negative Gearing has been in Australia for decades. Every Australian has heard of it, but many Australian don't exactly understanding what it means and what it can offer them especially when it comes to property investing.
Firstly, investing in the property asset class is not for everybody and you would want to consult your accountant before making any financial decisions. This article will highlight some of the pros and cons of investing the property asset class within Australia so that you can make a more informed decision when deciding to purchase within this asset class.
The concept of a negatively geared property is simply the ability to offset the losses that occurs when your purchase an investment property. Below is a simplified example of a typical investment that an investor may be presented with.
Assumptions:
- Property Value: $400,000
- Loan Amount: $360,000
- Personal Salary: $70,000
- Tax Rate (flat rate): 30%
Cash flow Analysis
- Rental Income: $16,000
- Interest Payments: $28,800
- Other Expenses: $3,000
- Net Cash flow: -$15,800 (Loss)
Property investors in Australia are allowed to offset the net investment losses against their taxable income before tax payable is calculated. All this means is that if your taxable income is $70,000 and you have an investment loss of say $10,000 a year, your taxable income will be reduced from $70,000 to $60,000. Since tax payable is calculated on taxable income you would want as many allowable expenses that can offset your taxable income. The two tables below will highly the major differences and we can see an additional savings of $4,740.
Without Negative Gearing
- Income: $70,000
- Taxable Income: $70,000
- Tax Payable: -$21,000
- After Tax Income: $49,000
- Investment Expense: -$15,800
- Disposable Income: $33,200
With Negative Gearing
- Income: $70,000
- Investment Expense: -$15,800
- Taxable Income: $54,200
- Tax Payable: -$16,260
- After Tax Income: $37,940
- Disposable Income: $37,940
As we can see from the above tables, the major advantage is the fact that property investors are given a tax relief for purchasing investment properties that loses money. And here lies the critical point.
Successful property investors invest in fundamentally good investment properties that they feel have a higher probability of increasing in capital value over the medium and long term. Accounting and taxation comes into the picture because it gives investors the true after tax picture of their investment decision.
However, unsuccessful property investors invest in any property that gives them the biggest tax relief regardless of property fundamentals. Due to the lack of understanding of simple tax and accounting principles, the unsuccessful property investor will increase their financial burden and may be holding an under-performing property.
Property selection is the tool used to identify between an incredible investment and an abysmal investment. Negative gearing merely forms part of the analysis used to determine the true cash outflow of investing in the property asset class. Understanding this will make or break your investment portfolio as the results is dramatically magnified since property is usually a leveraged investment.
Your Success Club > Articles > Negative Gearing - What Does it Really Mean?