What Is Negative Gearing?

activ8newbs on 25/10/2018 - 20:25

I need help to understand what is seemingly a simple concept.

Say I own an investment property and have a $200k income.

Mortgage Repayments per Year: $50,000
Rental Income per Year: $40,000

Therefore, I am negatively geared by $10,000.

Now:

An individual paying PAYG Tax on $200k will pay $54,097 plus 45c for each $1 over $180,000 i.e. $54,097 + ($20,000 x 0.45) = $63,097

Assuming we negatively gear by $10,000, we will be paying PAYG Tax on only $190k, which will be $54,097 + ($10,000 x 0.45) = $58,597

Therefore, I'm only saving $63,097 - $58,597 = $4,500

Net Effect:

We have lost $10,000 only to gain $4,500. Therefore, realised a net loss of $5,500.

Why on Earth would anyone negatively gear a property? Please help me understand the political fuss about Negative Gearing?

Thanks

Financial Negative Gearing

Comments

  • payton on 25/10/2018 - 20:33
    +14

    Say I own an investment property and have a $200k income

    I stopped reading there 😂

    • [Deactivated] on 25/10/2018 - 20:54
      +19

      I didn't quite stop until I saw the username

  • MrHyde on 25/10/2018 - 20:35
    +8

    Capital gain. In the one-year you've held the property, you would be expecting some gain in price. Say, it went up 20k.

    It cost you only 5.5k to earn 20k instead of 10k to earn 20k.

    Also, you can also deduct all expenses, and depreciation if property is newer, which makes a huge difference as depreciation is not a cash outlay, per se; but you get cash back

    • activ8newbs on 25/10/2018 - 20:47

      My understanding is that Depreciation needs to be paid back once you sell the property; correct?

      Also, I still don't understand how Capital Gain has anything to do with this?

      Why not have:
      Mortgage Repayments = $50k
      Rental Income = $50k

      Property Price increases by $20k.

      Net Effect: Free $20k equity! (Less CGT upon Sale)

      • MrHyde on 25/10/2018 - 20:52
        +1

        If you can find a cash flow positive property, that is always better… however, with low rental yields, negative gearing helps a little bit.

      • AusGP on 25/10/2018 - 22:23
        -4

        Yes it is but capital gains are taxed at 50%. So in effect you claim full losses now and pay on half your gains later.

        • Euphemistic on 26/10/2018 - 09:28

          Capital gains are not taxed at 50%. If you hold the investment for more than 12 months you include 50% of the gain as income and pay tax at your marginal rate.

          • AusGP on 26/10/2018 - 10:54

            @Euphemistic: Yes I forgot to explain it in detail. I meant to say half of your gains are taxed

            • argonbay on 26/10/2018 - 16:01
              +1

              @AusGP: Bill Shorten will change that!

              • AusGP on 26/10/2018 - 18:25

                @argonbay: Yeah to be honest it makes sense that something needs to change - either a change to negative gearing mechanism or the CGT discount.

      • stirlo on 26/10/2018 - 08:56

        Good luck finding a neutrally geared property that will experience reasonable capital gains. Most investors will be willing to negatively gear desirable properties so will bid up the price beyond the point where you can neutrally gear it.

        That leaves undesirable properties left over where you're gambling the value will rise despite other investors believing it won't. If you have amazing local knowledge that no one else has this is possible but it's not easy.

    • HeWhoKnows on 26/10/2018 - 17:33

      When you depreciate property you are reducing the acquision cost by the amount of depreciation. So when you do your CGT calculations you end up paying more capital gains tax. But given you only pay CGT on 50% of the gain you are still ahead!

  • myusername on 25/10/2018 - 20:38
    +5

    you're not rich enough to understand

  • dcep on 25/10/2018 - 20:51
    +2

    hence you speculate market going up all the time to realise the capital gain at the end while gaming on negative gearing to get you through without losing too much.

    the problem is, there will always be boom bust cycle and not everywhere is sydney where 500k apartment becomes 1m in 5 years.

    brisbane cbd apartment is lower than 10yrs ago.

    • [Deactivated] on 25/10/2018 - 20:57

      Is it good time to buy in Brisbane now?

      • dcep on 25/10/2018 - 21:09

        yes if you buy to live-in as your home.

        you can wait if you're saving for deposit, no hurry as prices will only go down from here.

    • Diji1 on 25/10/2018 - 22:55

      Historically Australia has not had boom bust cycles in real estate, we've had boom stagnation cycles instead. Investors don't lose their money although they lose access to use it somewhere else generally speaking.

  • xmail on 25/10/2018 - 21:02

    a net loss of $5,500

    But perhaps the property went up in value by $6,000 in that time. Hence a net gain of $500.

    Also, you are ignoring deprecation allowances. These are a critical part of making negative gearing profitable in most cases.

    • Diji1 on 25/10/2018 - 22:56

      Yeah but the gain isn't realised until the property is sold.

      • stirlo on 26/10/2018 - 08:57

        You won't get your Super until you're nearly 70, that doesn't stop salary sacrificing into it being a great investment idea.

      • xmail on 26/10/2018 - 14:05

        You're right, I guess it doesn't count. /s

        b.t.w any savings you put away for a rainy day also aren't realised until the rainy day.

  • chumlee on 25/10/2018 - 21:05
    +5

    Property developers & spruikers pushed negative gearing for their own benefit.

    Now we are in a declining property price market, the pain will be coming. Add increasing interest rates, clamp on interest only loans, high petrol prices, a large number of people will wish they never bought their investment property

    • jellykingdom on 26/10/2018 - 09:46
      +1

      i know it's easy to think like this, "haha look at those suckers who thought they'd get rich with property, and now they're feeling the pain"

      …except remember that all those people are suddenly going to stop injecting money back into the economy, start defaulting on their loans, etc etc and suddenly EVERYONE is feeling the pain!

      I get sick of reading this kind of stupid comments. Yes, developers and banks pushed negative gearing for their own benefit. But unfortunately we're all in teh mess together now.

      • chumlee on 26/10/2018 - 10:38
        +1

        My point is investors are buying a property with the main purpose of reducing tax, instead of creating wealth.

        Reducing tax v creating wealth have different mindsets and strategies.

        History always repeats itself and there are always booms and busts. People writing comments isn't going to save the economy

  • [Deactivated] on 25/10/2018 - 21:06
    +15

    What Is Negative Gearing

    In my car it's between the front seats and marked 'R'

  • websterp on 25/10/2018 - 21:15
    +5

    How's the AMG going?

  • Some Guy on 25/10/2018 - 21:22
    -1

    Negative gearing just softens the blow while you wait for a big capital gain payday to offset all those years of making a loss. Because house prices only ever increase, apparently, that'll be worth it. Then you need to worry about capital gains tax.

    So yep negative gearing is tax payer funded dud investment that drives up prices, rents and FHO out of the market, apparently.

    • HighAndDry on 26/10/2018 - 14:35

      Negative gearing literally means owners renting out properties at below break even rates. If anything, the fact it's possible means lower rents.

      • Some Guy on 28/10/2018 - 10:11

        I did say apparently. The effect that NG has on house prices and subsequent rents really depends on which article you're reading at the time. Plenty of reasoned rationale either way supported by specific examples. In general, there's varying results predicted.

        • HighAndDry on 29/10/2018 - 09:42

          Ah fair enough. I mean, a lot of people seemingly irrationally and emotionally dislike NG, so I can imagine them saying anything they think of about it. Next it'll be that NG poisoned their water supply and burned their crops…

  • mskeggs on 25/10/2018 - 21:22

    As others have said, it only makes sense if the capital gain (taxed at 50% of marginal rate) exceeds the losses.

  • miwahni on 25/10/2018 - 22:13
    +2

    It can be helpful if the reduction in taxable income drops you down into a lower tax bracket / out of Medicare levy surcharge territory. BTW, rejig your equation a little bit - it's only "Mortgage Repayments Per Year $50000" if your loan is IO - if it's PI, it's only the interest charged that you can claim, not the whole repayment. And don't forget the associated costs - managing agent fee, insurance, rates etc…. they all get deducted.

    At the moment, the loss made on your rental property can offset your PAYG or self employed income, for an overall lower taxable income. With the changes proposed by Labor, you can still claim all of your expenses etc but cannot offset the loss against your other income. So if you currently earn $100k + rent $20K but incur $25000 worth of expenses for the property, then your taxable income reduces to $95000. But under the proposed changes, if your rental return is $20k and expenses $25k, you can write off the rental return but your taxable income will remain at $100k.

    Having said all that, there's a lot to be said about positively-geared property. No-one ever went broke making a profit.

  • TheBilly on 25/10/2018 - 22:19

    You can buy properties that are cash flow neutral but negatively geared. Reason being you havent factored into account things like, insurance, depreciation etc.

  • TheMindsetTraveller on 25/10/2018 - 22:34
    +5

    You said:-

    Mortgage Repayments per Year: $50,000
    Rental Income per Year: $40,000

    Therefore, I am negatively geared by $10,000.

    I say:-

    Firstly, you are doing it ALL wrong if that's all you are deducting ;)

    You income is Rent, that's $40,000

    Your expenses include, but not limited to: Mortgage Repayment $50,000, Agents Fees/commission, say $2,200 pa (at 5.5%), Is is strata property, then you deduct strata fees - say $5,000, If it's land, deduct land tax, now deduct council fees, say $1,500, deduct water rates say $800, deduct building depreciation (from $40,000 income or close to $800pw, your property I am estimating is worth close to a million dollars) so expect depreciation, lets say around $20,000 for this year. Lets say you paid $1,000 for a few urgent repairs. Now, your expenses total roughly $80,500.

    So income $40,000 less expenses $80,500 = $40,500 loss for the year (and not the $10,000 you first stated). Does this look better now?

    The key with negative gearing (ie loss) is that you claim this against your taxable income. So in my rough calculations, your income drops from $200,000 to $159,500.

    Let's say you have three properties that do exactly the same thing and lose money, and your taxable income drops below $80,000 even though you actually $120,000 in rent money PLUS you have $200,000 income. Now, that drops you to the middle tax bracket even though your income is almost twice the minimum of $180,000 needed to get into the highest tax bracket.

    Ok, moving forward, once ANY of your property becomes positively geared after all that - well you go to your broker and get another loan to purchase ANOTHER investment property so you can negative gear once more. Rinse and repeat until you have 25 houses and can retire at the age of 40 years old.

    • HighAndDry on 26/10/2018 - 14:38
      +1

      Rinse and repeat until you have 25 houses and can retire at the age of 40 years old.

      That's the aim, but if you run into a market like this one and can't find renters or spare cashflow to cover your repayments, or worse, get told by Westpac to find another lender in a months time, then being leveraged to the hilt means you're forced to sell, crystallize huge losses, and wipe out the past decades worth of gains.

  • onetwothreefour on 26/10/2018 - 06:38

    Say I own an investment property

    Surely you mean investment car

  • mbck on 26/10/2018 - 08:20

    But why is gamora?

  • Youfah Mizzum on 26/10/2018 - 08:36
    +2

    DrunkOnTheGoodLife is mostly correct above.

    Rental income = $40,000 + taxable income = $200K so your taxable income = $240,000. Then you deduct stuff.
    Deduction 1 is already done for you, that is your employer would already have deducted a best-guess income tax from your gross income to give you your take home pay.
    Mortgage repayment = $50,000. This is NOT claimable on your income tax. Only the INTEREST PROPORTION of the mortgage repayment is a tax deduction. That's assuming you're paying a principal/interest loan. If it's just interest only - then yes the whole payment is deductible. But the principal component of a principal/interest repayment isn't deductible.
    And then there's also the the fees associated with maintaining the apartment - strata fees, maintenance fees and costs, landlord insurance, council rates.
    See DrunkOnTheGoodLife above. Basically correct.

    • TheMindsetTraveller on 26/10/2018 - 09:48

      Thanks mate,

      The OP will definitely need an accountant to guide them through what specifically is allowed to be claimed(deducted) and what is not.

      I was rushing when I typed up my comments; so yes to be correct - only the interest portion is only deductible, and with the building depreciation component the OP will need a proper Depreciation Report (and not just pull up a figure like what I did - but my guess of $20,000 will be pretty accurate based on a variety of Depreciation Reports I have obtained for myself in the past decade).

      Basically, anything a person spends to own and maintain an investment property, is generally deductible. You just need to be able to show/prove (to the ATO) that there was an expense against the investment - an accountant will answer those questions for them.

      I am not an accountant ;) Just another person who has used negative gearing on several properties for the past decade ;)

  • HeWhoKnows on 26/10/2018 - 17:23

    FROM A PROPERTY INVESTMENT EXPERT…..
    You dont need any numbers to explain negative gearing.
    Contrary to popular belief Negative gearing can only occur when the deductible expenses of your investment property exceed the income (rent) you receive from that property in any one tax year. i.e Your property is running at a LOSS or is cashlow negative!
    Deductibe property expenses include: council and water rates, land tax, repairs and maintenance and of course interest on the loan if it was taken out to fund the property as an investment. (not as your residence)

    Now under the present negative gearing rules….
    If you have other income - say you are employed at a job, you can offset your property losses against your other income.
    i.e The amount by which your deductible property expenses exceed your rental income can be used as a tax deduction against your salary income - thereby effectively reducing the amount of tax you pay that year on your other income (salary).

    Without negative gearing any investment property losses you incur in any one tax year would be carried forward into the subsequent tax year(s) until such time as the property becomes profitable or cash flow positive. This is expected to occur over time as rents increase or until you sell. At that time the accumulated losses can used to reduce your taxabale property income or taxable gain if you sell first. It may take a number of years to use up all your accumulated property losses. So the flip side to negative gearing is that you will not pay tax on your property income for many years to come!

    So all negative gearing does is to allow you to claim excess property expenses today instead of having to wait until tomorrow when the property investment starts returning a profit. You dont lose or gain any property expenses under either scenario. Its really just a matter of timing. i.e when you can claim the deduction.

    So dont fret if Labor wins the next election and does away with negative gearing. You will still have the right to claim your property tax deductions. It just means you will have to wait a little longer and in doing so, paying less tax tomorrow instead of today.

    Unfortunately as with everything financial - Labor just doesn't get it. They somehow think they will get more tax by removing negative gearing. Its a very short-sighted view because whatever they gain today, they lose tomorrow. Its a zero-sum equation.

    • AusGP on 26/10/2018 - 18:33

      I think Labor is trying to cool the housing market not get more tax to be honest - but the state of politics in Australia means they're playing this "we shouldn't be giving tax breaks to rich people" mantra and basically starting class warfare and win power that way.

      The truly rich will just hold it in companies and trusts and won't bother with negative gearing anyway, and claim losses later as you have stated above (which is entirely legitimate like any other business).

      But still I think a period of cooling of the property market is wise, provided no major crashes which would put a huge dent in the economy

    • argonbay on 27/10/2018 - 03:02

      Bill Short-sighted?

  • demiurge on 29/10/2018 - 18:45

    They are banking on the increase in value of the property.

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