Negative gearing explained

author-avatar By on August 20, 2021
Negative gearing explained

If you’re a property investor, negative gearing could help you save some serious cash on your investment property.

According to the Australian Taxation Office (ATO), the proportion of landlords who negatively geared recently fell below 60% for the first time on record, off the back of historically low-interest rates. Of the 2.2 million taxpayers who owned at least one rental property, 1.3 million declared a net rental loss in the 2018/19 financial year, with overall net rental income sitting at minus $3 billion.

If you’re a property investor or looking to become one, chances are you may join these ranks, as negative gearing can often be seen as an investor’s best friend. So, how does it work, what can you claim, and what are some of the benefits and drawbacks? Find out in this article.


Buying a home or looking to refinance? The table below features home loans with some of the lowest interest rates on the market for owner occupiers.


What is negative gearing?

Negative gearing occurs when you borrow money to make an investment, and the ongoing expenses of that investment are greater than the ongoing income you receive from your it. In this scenario, you may be able to deduct this ongoing loss from your total taxable income for the financial year, saving you on tax. This can be applied to any asset, be that property or shares. For the purpose of this article, we’ll focus on property.

But let’s step back a bit. What’s gearing? Gearing simply refers to borrowing money to buy an asset. There are two types of gearing: positive gearing and the aforementioned negative gearing. Positive gearing is the opposite of negative gearing, which means your annual income from your asset is greater than the tax-deductible expenses you’ve incurred through it during the financial year. When talking about property, that means your rental income is greater than the tax-deductible expenses you’ve forked out on the investment over the year.


How does negative gearing work?

There isn’t a set process defining how to negative gear, nor will you find it in legislation. The ATO states “your rental property is said to be ‘negatively geared' if your deductible expenses are more than the income you earn from the property.”

For that financial year, the ATO then deems the tax result of your property as a net rental loss. You then may be able to claim a deduction for that loss, bringing down your total taxable income for the year and saving you money on tax. If your income isn’t large enough to absorb the rental loss, you can carry it forward to the following financial year’s income.

What can you claim on negative gearing?

Deductions you can claim typically fall into things you the investor have paid for, not the tenant. These could include:

Refer to the ATO or an accountant where possible if you’re not sure whether a deduction falls into one of these categories.


How to calculate negative gearing

If you’re looking to get a rough idea of how you may calculate negative gearing, you can follow the process below:

  1. Calculate your property income: This will typically consist solely of the weekly rent your tenants are paying. Provided the property has been tenanted for the whole financial year, multiply the weekly rent by 52. If it’s sat vacant for any period, multiply the weekly rent by 52 minus the number of weeks it had no tenants.

  2. Calculate your property expenses: This will include any repair costs, interest payments on your mortgage, insurance, and property management fees.

  3. Subtract depreciation: As your property ages, so does its contents, bringing down their value. Using a depreciation schedule can help you figure out how much value items like carpets, ovens, and wooden floors have decreased in value, which you can also subtract from your taxable income.

The above process may give you an idea of how much you’re negatively gearing, but it’s often recommended you consult an accountant or the ATO, who are likely more experienced and knowledgeable than the everyday punter on the matter.


Negative gearing case study

Negan Geary buys an investment property valued at $500,000. He has a $100,000 deposit (20% of the property’s value) and takes out a loan for $400,000.

The loan is an interest-only mortgage, popular among investors, repaid over 25 years with a five-year interest-only period, at an interest rate of 3.50% p.a.

Negan’s monthly repayments are $1,168, or $14,016 for the year. He also had to pay $1,000 to fix the air conditioning at the property, $3,000 on home and contents insurance, and $2,000 in property management fees. Negan’s total investment expenses for the year came to $19,016.

Negan charged $300 in weekly rent, taking his annual income to $15,600.

Negan paid $3,416 more in expenses than what he earned in rental income. As a result, his property is negatively geared and he may be able to deduct that amount from his taxable income for the year.


What are the risks of negative gearing?

Negative gearing is a popular and often viable investment strategy, but that doesn't mean it comes without risk. Check out some of the questions below you should be asking yourself before deciding to negative gear.

What happens if you can’t find tenants for the property?

Arguably the most important thing about being a landlord is having a property with tenants in it. If your property is vacant, you’re probably losing money at a rapid rate. For example, if your property sits vacant for just one month and you’re charging $400 rent, you’ve lost out on $1,600. That’s a serious chunk of money.

If you’re planning to negatively gear, you’re accepting you’re making a loss. But if you don’t have tenants, that loss is greater and compounded even further. You will more than likely still have a mortgage and bills to pay, which your normal salary, if you have one, might not cover.

It’s vital you understand that although negative gearing can be a great strategy, you’re still losing money. The money has to come from somewhere, and if you can’t afford to have an empty property, you could get into financial strife.

What if the property doesn’t increase in value?

Negative gearing is often a successful strategy for investors as they carry their loss forward to a year where they plan to sell the property. The plan typically works so that the property has risen in value, which offsets the loss incurred in previous financial years, and also makes the investor a profit.

However, if your property doesn’t rise in value, you could be in trouble. You may be facing a situation where you’ve been negatively gearing for five years, losing thousands of dollars each year with the goal to sell when it goes up in value, but it hasn’t. At this point, you’re in serious debt and may have to sell at loss to cover your costs.

This is why if you’re planning to negative gear an investment property, it’s extremely important to buy in suburbs with strong capital growth opportunities. These suburbs are also typically places people want to live, meaning your property wouldn’t be sitting vacant.

What will I do if interest rates rise?

Investors are benefitting from historically low-interest rates lately, which has seen many come flooding into the market. Low interest rates mean your monthly repayments are likely to be low, so if you’re negatively gearing, your losses may not be too big for the financial year.

But how could you handle it if interest rates rose, which they’re expected to do in coming years? Could you afford your repayments still? A vacant property would be even more financially damaging if this occurred.

When budgeting and deciding to negative gear, it’s vital you leave yourself a buffer in the event interest rates do rise. If you haven’t planned for this eventuality, just a small interest rate hike could send you into crippling debt and ruin your investment.


Should I use negative gearing?

If you’re tossing up whether to use negative gearing, here are some of the questions you should be asking yourself before making a decision:

  • Does my property have strong capital growth opportunities?

  • Can I afford to incur the losses associated with negative gearing for a number of years?

  • How long can I afford to negatively gear before I need the property to be positively geared?

  • Can I afford my home loan repayments in the event the property goes untenanted?

  • Can I afford my home loan repayments in the event interest rates rise?

  • Will the potential profit made from selling the home be greater than the losses I incur when negatively gearing?

  • Is this the most suitable investment strategy for me or should I explore other investment avenues?

If you still can’t make a decision, consider consulting a financial adviser.


What’s the point of negative gearing?

Negative gearing has been a hot topic in Australian politics in the last few years with some groups questioning the validity of the favourable tax treatment it gets. Labor went to the 2016 and 2019 federal election promising to limit the tax benefits of negative gearing to new properties only and halving the 50% capital gains tax discount. The proposed policy faced fierce resistance from the government and property groups, and is widely considered to have been a major factor in Labor’s losses at those elections. Labor leader Anthony Albanese announced in July 2021 he would be dumping the idea.

You might have read this article and thought, why do we even have tax benefits for negative gearing? Being such a politically charged issue affecting so many people, it’s worth presenting some of the arguments for and against the policy:

For:

  • It acts as an incentive to prospective investors. Greater investment activity means more houses get built, which increases the housing supply in Australia.

  • Many landlords are mum and dad investors who aren’t particularly well off. Negative gearing eases the financial burden of owning property and encourages more to become investors.

  • Encouraging more people to invest means there could be fewer people reliant on the age pension

  • Scrapping negative gearing could mean it's more expensive to be a landlord. They may need to offset these costs by raising rents.

Against:

  • Greater investment activity could mean there is less housing supply for first home buyers and owner-occupiers. This might raise house prices and make it harder to enter the market or upgrade to a new home.

  • Negative gearing helps many people who are already asset-rich and don’t need the tax break i.e the rich getting richer.

  • Allowing negative gearing deductions costs the government billions in lost tax revenue each year.


Pros and cons of negative gearing

Negative gearing can be a great way for investors to save on tax but it’s not without its pitfalls. Here are some of the pros and cons:

Pros:

  • Potential tax savings by offsetting losses you incur in the year

  • If your property has grown in value, when it comes time to sell, you may be able to make back the losses you’ve incurred

  • Claiming for depreciation can further reduce your taxable income

Cons:

  • You need to be able to afford the loss you’re incurring

  • If your property doesn’t increase in value your strategy may not be viable

  • If interest rates rise your losses will increase, which you need to be able to afford

  • Your borrowing power may decrease if you wish to purchase another property


Photo by Leon Seibert on Unsplash

Disclaimers

The entire market was not considered in selecting the above products. Rather, a cut-down portion of the market has been considered which includes retail products from at least the big four banks, the top 10 customer-owned institutions and Australia’s larger non-banks:

  • The big four banks are: ANZ, CBA, NAB and Westpac
  • The top 10 customer-owned Institutions are the ten largest mutual banks, credit unions and building societies in Australia, ranked by assets under management in November 2020. They are (in descending order): Great Southern Bank, Newcastle Permanent, Heritage Bank, Peoples’ Choice Credit Union, Teachers Mutual Bank, Greater Bank, IMB Bank, Beyond Bank, Bank Australia and P&N Bank.
  • The larger non-bank lenders are those who (in 2020) has more than $9 billion in Australian funded loans and advances. These groups are: Resimac, Pepper, Liberty and Firstmac.
  • If you click on a product link and you are referred to a Product or Service Provider’s web page, it is highly likely that a commercial relationship exists between that Product or Service Provider and Savings.com.au

Some providers' products may not be available in all states. To be considered, the product and rate must be clearly published on the product provider's web site.

In the interests of full disclosure, Savings.com.au, Performance Drive and Loans.com.au are part of the Firstmac Group. To read about how Savings.com.au manages potential conflicts of interest, along with how we get paid, please click through onto the web site links.

*Comparison rate is based on a loan of $150,000 over a term of 25 years. Please note the comparison rate only applies to the examples given. Different loan amounts and terms will result in different comparison rates. Costs such as redraw fees and costs savings, such as fee waivers, are not included in the comparison rate but may influence the cost of the loan.

Latest Articles

author-avatar
Alex joined Savings.com.au as a finance journalist in 2019. He enjoys covering in-depth economical releases and breaking down how they might affect the everyday punter. He is passionate about providing Australians with the information and tools needed to make them financially stable for their futures.

Collections:

Be Savings smart.
Subscribe for free money newsletters.

By subscribing you agree to the Savings Privacy Policy