Negative Gearing in Australia: Definition, Advantages and Disadvantages
To make the most of their investment, property investors employ various strategies. In Australia, many Aussies practice negative gearing to afford property expenses and assets, despite its controversial nature.
Negative gearing has its specific benefits and risks. It’s not suitable for everyone, including Australian expats. Understand how negative gearing works and its advantages and disadvantages before investing in your property from overseas.
What is Negative Gearing?
Negative gearing involves borrowing money, where expenses exceed investment returns in a negatively geared property. Property investors can deduct their losses from their capital gains tax.
How Negative Gearing Works in Australia
Consider this: If you buy a property for $600,000 with a 30% deposit of $180,000 and pay an interest rate of 4% over thirty years, you may experience a net rental loss of $1,149.04 in the first year.
However, negative gearing can allow you to claim tax deductions associated with investment properties in the same year, potentially enhancing your capital gain more than in a positively geared property. Negative gearing also applies to shares and bonds permitted under Australian tax laws but can only be claimed against income earned in Australia as an Australian expat.
It is necessary to have taxable income in Australia for negative gearing to be worthwhile, but losses can be carried forward to offset future income or capital gains tax.
Why is Negative Gearing So Popular in Australia?
Around 68% of Australian property investors used negative gearing for tax benefits in 2012-13, according to the Treasury.
While negative gearing is often associated with high-income earners, it can also benefit the community by reducing rental prices and increasing housing construction.
Negative gearing has faced criticism throughout Australia’s history, and attempts to limit it has been reversed by the government, such as the 2010 Henry Tax Review.
The Henry Tax Review
The government designed the Henry Tax review to provide a blueprint for tax reform for the coming decades. The report highlighted that wealthy property investors were gaining an undue advantage from tax concessions funded by regular taxpayers.
The review proposed a savings income discount that would replace the capital gains tax discount. This new policy would cover interest from bank accounts, rental income, capital gains, and expenses from share investments, limiting tax-deductible claims for real estate investment to just 60%.
Despite these recommendations, people rejected the new policy favouring negative gearing because it looked to increase rental supply and make the property more affordable.
What Can You Claim on Negative Gearing in Australia?
Suppose you rent or genuinely make your negatively geared property available for rent. In that case, you can claim deductions on most expenses you incur in the income year, including interest expenses, council rates, strata fees, maintenance costs, agent fees, and any other income-producing payment.
Tax Deductions that Can Be Claimed
In a given income year, you can claim the following property expenses:
There is another set of expenses that you can claim over several years, which includes:
- Capital works: renovations, extensions, and other property improvements beyond simple wear and tear
- Borrowing expenses: Lender’s Mortgage Insurance (LMI), loan establishment fees, broker fees, solicitors’ fees, and stamp duty charged on the mortgage
- Depreciating assets: depreciation of value in assets that aren’t a permanent part of the property premises, such as carpets, curtains, furniture and appliances
To ensure that you can claim a tax deduction for your investment property, keep detailed records of all expenses you incur. If you co-own the rental property or if it is not available to rent for part of the year, the amount you can claim for a tax deduction will be diminished.
Visit the Australian Tax Office website for more information on what expenses you can claim on your negatively geared property.
Tax Deductions that Cannot Be Claimed
You can claim most investment property expenses in Australia for tax deductions, but there are some exceptions.
The following borrowing costs cannot be claimed as deductible expenses:
- Stamp duty
- The amount borrowed for the property
- Loan balances for the property
- Principal payments on the loan
- Legal fees for the purchase of the property
- Lender’s Mortgage Insurance premiums
- The decline in value of second-hand assets within the property
- Borrowing expenses on any portion of the loan used for private purposes
- Expenses related to the depreciation of assets, such as carpets, curtains, furniture, and appliances installed before you became the rental property owner
Please visit the Australian Tax Office website to learn more about expenses you cannot claim on your negatively geared property.
How Much Can You Claim on Negative Gearing in Australia?
Suppose your investment property incurs a net loss. In that case, you can deduct that amount from your assessable income as long as the expenses are eligible for deduction.
For instance, if your property records a loss of $1,000 in a given year, you can subtract that amount from your assessable income. It will help determine your taxable income, which will determine the amount of tax you owe.
You can reduce the tax payable by claiming eligible expenses on your negatively geared property. In some instances, it can even lower your tax bracket.
How to Calculate Negative Gearing
Negative gearing allows Australian investors to use losses on rental properties to reduce taxable income. Follow these key steps to calculate the potential tax deduction from negative gearing:
1. Calculate Total Rental Income
This includes all income generated from the property for the tax year, such as:
- Rent payments received
- Rental bond money retained
Record this figure as (A).
2. Calculate Total Deductible Expenses
These expenses are tax deductible for rental properties. Common examples include:
- Loan payments
- Property maintenance and repairs
- Management fees
- Rates, land tax, and insurance
- Advertising and rental inspection trips
Tally all of these expenses for the year and record as (B).
3. Calculate Net Rental Loss
Use this formula:
Net Rental Loss = Total Deductible Expenses (B) – Total Rental Income (A)
If (B) exceeds (A), the result will be a net rental loss figure.
4. Use Net Rental Loss to Offset Assessable Income
This final net rental loss can be used to lower your overall taxable income earned from other sources, such as your salary. This ultimately reduces your tax obligation.
Consult our tax advisors for advice on utilising negative gearing and maintaining accurate documentation.
Negative gearing only applies to Australian income tax and properties, not foreign income or property. Calculating your investment returns is essential to determine if negative gearing is the right strategy for you as an Australian expat.
Remember that you can only apply negative gearing to your Australian income tax, which doesn’t work for overseas property or foreign tax offices. For instance, you can’t claim tax deductions on your income from the US or UK (unless allowed under specific double taxation agreements).
Negative gearing only applies to income, tax, and properties within Australia.
What Expenses Can I Deduct on Negative Gearing?
- Interest payments on investment loans
- Maintenance and property management costs
- Depreciation on capital goods like dishwashers or washing machines in rental properties. Strata fees, building expenses, advertising, insurance, land tax, stamp duty, repairs
- Other expenses like bank fees, council rates, and capital work costs
Is Negative Gearing Right For Me as an Expat?
Negative gearing on property investments has the potential to provide benefits to both renters and landlords. When done right, it can result in lower rental fees, which can benefit immediate renters and help decrease competition and rent prices for other property investors.
Negative gearing is a helpful approach for expats to lower and postpone tax payments, providing more money for immediate use. You can invest these funds in other areas, such as buying more investment properties or Australian shares (which don’t have capital gains tax for non-residents).
Depending on your priorities, risk tolerance, and financial circumstances, positive and negative gearing tactics are worth considering.
Advantages of Negative Gearing
Negative gearing on the property can benefit both renters and landlords by potentially resulting in lower rental fees, fostering long-term relationships, lowering agency fees, and offsetting taxable income.
Negative gearing can also perform well in the property market and lead to long-term property value growth.
However, it is essential to evaluate the risks and ensure that the costs of investment loan repayments can be covered, as the benefits of negative gearing are typically long-term.
Disadvantages of Negative Gearing
Negative gearing in property investment comes with significant risks. The primary threats include the potential loss of capital and the inability to cover loan repayments, leading to the repossession of your property.
Falling property prices in the area where you invested are also a risk. It is essential to research neighbourhood property prices and finds an investment loan with reasonable interest rates.
Negative gearing is a long-term investment that can tie up your capital for a decade or more. Careful consideration of risks and disadvantages is necessary, including the possibility of cash flow problems, difficulty finding tenants, market drops, and loan repayments.
Consulting with a financial advisor, tax accountant, and mortgage broker can you help make an informed decision.
Positive Gearing vs Negative Gearing
Positive gearing generates enough revenue to cover all expenses, making it a wise investment strategy. However, negative gearing is the way to long-term capital growth over income.
A well-rounded investment portfolio should include both types of properties.
Negative gearing usually produces better capital growth because it reduces taxable income. Nonetheless, negative gearing involves intentionally not making a profit and comes with significant risks.
If you intend to utilise negative gearing, pay attention to property values, keep detailed records of all expenses and consult a tax advisor.
Necessary Considerations for Negative Gearing
Choosing a gearing strategy depends on many factors, with annual income being a crucial consideration. If your income is near the threshold of a higher tax bracket, negative gearing tax deductions could save you thousands of dollars.
To determine which strategy to use, calculate your taxable income with and without the investment property and compare the tax implications of positively and negatively geared properties.
If the tax benefits are comparable, negative gearing may be the better option, but consider finding a negatively geared property with good capital growth potential.
Property appreciation can offset expenses when you sell the property.
When to Pursue Positive Gearing
Positive gearing is often considered a more dependable and stable investment strategy, particularly for those with a lower income tax rate. A net rental income surplus can enhance your borrowing ability and accelerate the repayment of your investment loan.
That will increase your home equity and free up cash for further investment opportunities, such as purchasing another property. However, the downside of this approach is the increased tax liability.
Nonetheless, positive gearing is often the preferred choice for beginner property investors.
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FAQs About Negative Gearing
Negative gearing is a tax strategy that allows Australian property investors to offset the expenses of owning and maintaining a rental property against their taxable income.
This means that if the expenses of owning a rental property are greater than the income it generates, the investor can claim a tax deduction for the difference.
Negative gearing has a unique history in Australia, as it is a general practice, unlike in most countries. It means that, technically, you can claim the amount of money on a tax return through negative gearing is unlimited.
It’s also worth noting that Australian expats are eligible for negative gearing. Still, they need to pay more attention to the 50% capital gain tax concession for investment properties available to those residing in Australia.
Negative gearing often increases the property’s value over time, so you can recoup its initial investment when you sell it. For Australian investors, negative gearing can be an effective investment technique leading to long-term financial gain.
However, it typically involves lowering the rental rates of the property.
Australians have traditionally utilised negative gearing as a property tax strategy. However, there have been some periods of fluctuation in its acceptance. For instance, there were brief limitations on negative gearing in Victoria during the 1980s and again in 2010.
Nevertheless, the Australian Taxation Office has consistently promoted the practice of negative gearing.
Tax savings from negative gearing depend on the property size, maintenance, and interest expenses. The savings are the difference between rental income and expenses.
For example, if you lost $1,149.04 with $5,400 rental income and $5,549.04 expenses, you can claim $1,149.04 on your negatively geared property as a tax refund.
Positive gearing may be better if your salary is below the minimum income tax rate because you cannot reduce your overall tax bill.
Negative gearing is a type of investment that typically requires a long-term commitment. Initially, property owners may experience financial losses, so there may be better investment strategies for those who need quick access to capital.
However, suppose an investor has the financial means to cover the monthly expenses of their property despite incurring losses on rental income. In that case, negative gearing may result in substantial long-term tax savings and an increase in the property’s value.
Investors with high assessable income often prefer negative gearing, typically utilised when the negatively geared property appreciates.
However, whether negative gearing is the right strategy depends on factors such as your tax bracket, the property’s expenses, the amount of interest paid towards the loan, and more.
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