What is negative gearing and why was it talked about pre-election?

Posted On: Tuesday, July 5th, 2016  In: Blog

The elections are over but negative gearing will remain a useful investment tactic especially for smaller investors that have few options for increasing their wealth. They mainly invest in rental home units.

Our tax laws generally tax all income and against that income you can claim all the expenses in earning that income including interest. However if the value of the property goes up then that capital gain is only taxed when you dispose of that property. This disposal is usually a long time away even as long as 30 to 50 years. Currently if the property is owned by an individual and not a company, then the capital gain is halved before being added to your taxable income. The rationale for this halving is that the gain is often mainly arising from inflation so is not a real gain and there thus needs to be an adjustment for inflation. In the early years of capital gains tax, the adjustment was based on the rate of inflation.

negative gearing

Thus in your tax return you declare the rent as income and then you can claim the following; council and water rates, land tax, strata fees if it is a home unit, agent’s fees for collecting the rent or for letting the property, repairs but not improvements, insurance and then the interest on any loan used to buy the property. You can also claim depreciation of capital assets like carpets, ovens, hot water heaters and curtains but not built-in cupboards or the bathroom. If the property was built after 1985,  then you can also claim a proportion, usually 2.5%, of the cost of the building but not the land. It is usual to get a quantity surveyor to give you this figure.

If you have borrowed a reasonable proportion of the purchase price then the expenses and the interest will be larger than the rent received. This is then termed negative gearing (borrowing). Under current laws, this is allowed to be offset against your other income in your tax return and thus depending on your tax rate you will pay less tax or get a refund.

The tax laws already make adjustments for investment losses for some tax concessions. The election argument was that the rich people use this as a tax avoidance mechanism. Our experience is the opposite. The seriously rich structure their affairs so they make no losses and it is the professionals and tradesmen that negatively gear.

However be warned this loss is a real loss that you have to make up from your other income. The tax refund only covers part of the loss depending on your tax rate. Remember that you will continue making and paying for the loss until you sell the property, the rents go up or you pay off part of the loan.

This real loss only becomes a profit when the value of the property goes up. Residential property goes up in cycles. The previous up swing was in 2003 then the market was flat till 2013/15, a ten to twelve year period. So you must be a long term investor. The classic error here is to buy in 2003 then get frustrated with no capital gain and sell in 2012.

Like any investment, you need to do your numbers and homework. Not every property is a suitable investment. You thus should seek professional advice and certainly not rely on this simple explanation.

Attending our seminar sponsored jointly by Ku-ring-gai Chamber of Commerce and Peter Vickers Business Group on 28th July at 6pm,  will further assist your research to help you understand if investing in property is right for you. For more information or to reserve a place email kathryn@pva.com.au

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