Negative Gearing

Property – What is Negative Gearing?

Creating wealth through purchasing an investment property is a well established practice in Australia.   The attraction of borrowing or gearing to invest is that it enables you to invest in shares or property that might otherwise have been unaffordable.  For individuals, the negative gearing loss can also be offset against other assessable income.  Your tax benefit will depend on your marginal rate of income tax.

Negative gearing by definition is where you borrow to acquire an investment and the interest and other tax deductible expenses (including loan interest) incurred exceed the income derived from the investment.  While negative gearing is commonly associated with rental properties, it can also be applied to other types of income-producing investments such as shares and managed funds.    

The Risks

Negative gearing can be a risky business.  While gearing can amplify your gains, it can also magnify your losses.  There is no better example than the 2008 US sub-prime lending crisis where the collapse of the US Property Market left some 30% of mortgagees with a loan balance higher than the value of their property.

If you negatively gear property, you need to understand some important points:

• Properties are expected to generate profits only through capital gains and the gains need to be greater than the total losses incurred over the course of the holding period.  Of course, there is no guarantee that the value of the property will appreciate, or at least appreciate enough to cover the losses incurred during the holding period.

• Investing in property requires planning.   Extra caution must be exercised when a property is projected to generate a negative cash flow. Tax benefits should only be an incidental reason for the property purchase.

• For taxation purposes, depreciation on the building could be tax deductible; however, the depreciation also reduces the ‘cost base’ of the property.  The greater the depreciation you apply on your property, the lower the cost base value which may result in a larger taxable capital gain on sale.

• Negative gearing implies a negative cashflow that you need to fund from other sources, therefore negative gearing isn’t necessarily suitable for all investors.

• The use of negative gearing offers a lot more people the opportunity for wealth creation that they would not be able to generate otherwise.  Apart from the opportunity to increase your wealth by way of capital growth in the value of an asset, you may be able to take advantage of tax savings by way of negative gearing.  However, any taxation benefits or implications will depend on your personal situation and the type of investment you choose. 

Expenses for which you can claim an immediate deduction

Expenses for which you may be entitled to an immediate deduction in the income year you incur the expense include:

• advertising for tenants
• bank charges
• body corporate fees and charges
• cleaning
• council rates
• electricity and gas
• gardening and lawn mowing
• in-house audio/video service charges
• insurance
  • building
  • contents
  • public liability
• interest on loans
• land tax
• lease document expenses
  • preparation
  • registration
  • stamp duty
• legal expenses (excluding acquisition costs and borrowing costs)
• mortgage discharge expenses
• pest control
• property agent’s fees and commission
• quantity surveyor’s fees
• repairs and maintenance
• secretarial and bookkeeping fees
• security patrol fees
• servicing costs – for example, servicing a water heater
• stationery and postage
• telephone calls and rental
• tax-related expenses
• travel and car expenses
  • rent collection
  • inspection of property
  • maintenance of property
• water charges.

You can claim a deduction for these expenses only if you actually incur them and they are not paid by the tenant.

Expenses deductible over a number of income years

There are three types of expenses you may incur for your rental property that may be claimed over a number of income years:

• borrowing expenses
• amounts for decline in value of depreciating assets
• capital works deductions.