How to Use Negative Gearing in Property to Pay Less Tax
Negative gearing is an investment strategy designed to reduce the holding costs of your investment property. The word ‘gear’ refers to managing the costs and gains incurred from your investment, which can include property, as well as stocks and shares.
In the context of property, gearing generally refers to negative and positive gearing.
Positive gearing – relates to borrowing to invest, with the property generating positive income or capital gains
Negative gearing – relates to borrowing to invest, with the property generating a loss (negative income), which can be claimed as a tax deduction
Wait, How Can Losing Money be a Good Thing?
The reason why property investors use negative gearing is to lower their tax liability, while increasing potential capital gains. In other words, if your investment property incurs a loss, you can claim a tax deduction or a tax offset on your income. This tax offset can then be used to lower your tax bracket, allowing you to pay less tax.
While this strategy may seem like you’re gaming the system, it’s a perfectly legal way for taxpayers, especially high-income earners, to build wealth with the assistance of the Australian tax system.
You’re probably wondering how your investment property can generate revenue without positive cash flow. Fortunately, a property that’s chosen carefully can enjoy an increase in rental returns over the long run, eventually changing a negatively geared property to a positively geared one. In turn, this should allow you to recoup income losses through lower tax payments and increased rental rates.
Why Should I Invest in Negatively Geared Properties?
More often than not, positively geared properties are found in unappealing areas or far from core infrastructure, which means they don’t get as much capital growth as negatively geared properties. Moreover, a positively geared property isn’t as effective as reducing your tax liability; in fact, you might just be required to pay more tax on income incurred from a positively geared property.
Negative Gearing Pitfalls
But negative gearing isn’t perfect, as many mortgage brokers will tell you. The success of negative gearing your investment boils down to the quality of the property, which is central to the rent it draws. Negative gearing only works when the your investment’s ROI, from capital growth and yield, exceeds its total cost.
Don’t Rely on Tax Savings
That said, you shouldn’t invest in a property only with the intention of saving tax. It would be meaningless to do so without any returns. Many mortgage brokers have seen hundreds of investors make this mistake.
With solid research, it’s possible to acquire a property that will rake in the capital gains, courtesy of the rent from tenants. This, paired with depreciation, should allow you to enjoy positive cash flow.
One way of ensuring this is to take advantage of all tax-deductible depreciation allowances allowed by the Tax Office. As a rule of thumb, the newer your investment property, the higher its depreciation levels are. For instance, construction expenses can be depreciated at a level of 2.5% over a 40-year period.