Negative Gearing

Negative gearing has helped thousands of Australians use part of their taxes to pay off investment properties and accumulate wealth. We look closer at the advantages of negative gearing.

Wikipedia defines Negative Gearing as:

A form of financial leverage whereby an investor borrows money to acquire an income-producing investment and the gross income generated by the investment (at least in the short term) is less than the cost of owning and managing the investment, including depreciation and interest charged on the loan (but excluding capital repayments).

This allows the application of property losses arising from negative gearing against other types of income, such as wage or business income.

TAX BENEFITS FOR THE INVESTOR

AUSTRALIAN TAX RATES

MARGINAL TAX RATES

The marginal tax rate is the percentage of tax applied to your income for each tax bracket in which you qualify. It sets the rate of tax that each extra dollar earned is charged and also the tax saved for every dollar of deduction to the next tax bracket.

Eg: A person earning $100k has a marginal rate of $37%. A tax deduction of $10k would get a tax rebate of $3,700 back to the tax payer.

Simplified Negative Gearing Example - BEN vs TED

Ben and Ted both earn $90,000 pa. and have $50,000 to invest. Ben buys and investment property and Ted puts his money into the bank.

Ben's Investment

Ben buys a property for $300,000 renting at $300 per week and borrows $250,000 at 5% interest only.

Income

Rent & $300 pw + $15,600

Less Expenses

Interest                   $12,500
Council Rates        $ 1,200
Water Rates           $ 1,300
Body Corporate     $ 4,400

Total Expenses – $19,400

Shortfall (Tax Deduction) -$ 3,800

Because Ben’s marginal tax rate is 37% (as per the above chart) he gets a tax reduction or rebate of 37% of his net expenses. Hence:

Ben’s expense outlay          $3,800
Tax Rebate @ 37%           $1,406 (37% of $3,800)
   Ben’s actual holding cost $2,394

CAPITAL GAIN

If the property increases by 3% being $9,000 ($300k* 5%) then Ben has made an after-tax gain of $9,000 – $2,394 = $6,606

Ted's Investment

Now look what happened to Ted’s $50,000 invested in the bank at 3% interest.

Interest Received @ 3% $1,500
Less Tax due on additional income at 37% $ 555

Ted’s after-Tax Gain $ 945
Ben’s after Tax Gain $6,606

NOTE: The Taxman
Gives Ben a rebate of $1,406 but
Taxes Ted -$555.

When you couple the tax benefits of Negative Gearing with the capital growth of the property leveraged by the amount borrowed you can see why property investment has traditionally been the our most attractive wealth creation investment.

Note: The above calculations are over-simplified to make it easier to understand. A more thorough and accurate estimate can be achieved using the Feasibility Plus calculator