Negative Gearing guide

 Negative Gearing

Negative gearing can be a great way to get your foot in the door to the investment property market, but it pays to do your homework first so you’re not left with a massive loan you can’t afford to pay. It is important to seek advice from a qualified expert who can advise you on the taxation and financial implications. Mortgage brokers generally will not be able to give you such advice, so you’ll need to consult an accountant or a licensed financial planner. The following information should not be considered to be investment or financial advice.
Negative gearing is defined as borrowing to invest, where any income you receive from the investment is less than your borrowing costs and the costs of acquiring and maintaining the investment. These losses can then be used to reduce your taxable income and hence potentially reduce your tax bill – perhaps even qualify you for a tax refund.
Take this example. David saved a $50,000 deposit which he used to purchase a $500,000 investment property. He borrowed $450,000 to fund the remainder and covered all of the additional purchasing costs from his own pocket. He plans to keep the house for around 10 years, then sell it and repay the loan in full. The house is currently tenanted at $1400 per month but David’s loan repayments (interest only) are $3495 per month, leaving a shortfall of $2095 per month, which accumulates as $25,140 per year. At the end of each financial year, David’s taxable income (upon which his tax liability is calculated) can be nominally reduced by $25,140.
A popular wealth creation strategy, negative gearing lets everyday consumers invest in the property market through access to additional funds. The intention of all gearing for investment purposes is to access a larger pool of money, namely the investor’s own stake together with outside loan funds, than if only a smaller pool - the investor’s own stake by itself - had been used, says Nick Renton, author of Understanding Investment Property and Negative Gearing. This produces a much higher net return for the investor and a larger benefit from inflation.
Like any investment, there are uncontrollable factors that could impact on your plans, especially in suburbs that have experienced negative value growth in the last year or two. It’s also important to consider the possible impact of any interest rate rises or having an investment property untenanted for an extended period of time.
While negative gearing can be an effective way to make financial gains, Nick Renton cautions investors to thoroughly consider the pros and cons first. Apart from the possibility of making a loss instead of a profit, a borrower can also face the situation that he or she will not have the necessary cash resources to repay the loan on its due date, or at all, and that the lender will be unwilling in the circumstances to roll over the loan.

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