Negative Gearing & Property
The real benefits of negative gearing are only realized when you combine the correct tax and financial advice with a property in the right location funded by the most suitable loan product. You should always seek expert professional advice to make sure the purchase is within your budget and will provide long term taxation and financial benefits.
By definition, negative gearing is where you borrow to acquire an income producing asset and the interest and other tax deductible costs you incur exceed the income you receive from the investment. Creating wealth through purchasing an investment property is a well established practice in this country, however, negative gearing can also apply to other types of income producing investments such as shares and managed funds.
The attraction of borrowing or ‘gearing’ is that you can invest in shares or property that might otherwise have been unaffordable. For individuals, the loss can also be offset against other assessable income and the tax benefit will depend on your marginal tax rate.
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The Risks
While gearing can amplify your gains, it can also magnify your losses. For example, it is estimated that the 2008 US sub-prime lending crisis left close to 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:
- Investing in property is usually a medium to long term investment and requires planning. Extra caution must be exercised when a property is projected to generate a negative cash flow for a number of years.
- Properties are expected to generate profits only through Capital Gains and there is no guarantee that the value of the property will appreciate enough during the holding period to cover your losses.
- You have to remember that the family home is a purchase from the heart while an investment property needs to be a purchase from the head. You’ve heard the old saying that the three most important things when buying a property are: ‘location, location, location’ and this is even more important when buying an investment property.
Negative Gearing isn’t suitable for all investors and the tax benefits should not be the only reason for the property purchase. Although it can lower your tax liability, the tax implications will depend on your personal situation and the type of investment you choose. Negative Gearing implies a negative cashflow that you need to fund from other sources.
Client Testimonials
“McHenry Partners have been supporting our building and development business for many years and find them to provide a brilliant service. I’m one to focus on the building operation of the business and prefer not to be dealing with the financial management side of the business. McHenry Partners support us with bookkeeping, accounting and tax services for a fixed monthly fee which works really well. It allows me to focus on what I’m passionate about.”
Darren Gould
Redhouse Developments
“McHenry Partners have been our Accountants for many years and we have always found them to be professional and very supportive. When I retired from the business they were able to assist with the sale of my shares to the remaining partner and my transition from the business. Their Financial Planning services were able to set up my Self Managed Super Fund and help me manage my investments which I am very happy with. I have even appointed Steve McHenry as my back up Power of Attorney given the trust and confidence I have.”
Craig Harrison
“While we felt we had great educational products and services, we were struggling to effectively market these to increase sales and our business seemed to be ‘treading water’. McHenry Partners really helped us to focus on the key profitable services and clarified the target market to promote these services. We contracted the right sales people with incentives for them to perform well. As a result our sales have doubled in each of the last two years without increasing administration staff. Our quarterly consulting meetings with McHenry Partners involving discussing our recent financial performance but more importantly guides us on what actions we need to do to improve the business over the following three months. Our business has come a long way in a short period of time.”
Donna Bowman
Enhance Your Future
We have been conducting business with McHenry Partners for 14 years, firstly just for taxation purposes but also financial planning and retirement strategies.
Sam Adigrati from Vostro Private Wealth has been very supportive of our financial investment matters. When there is any information we require about our financial affairs, having both Vostro Private Wealth and McHenry Partners, we know we have the best of both worlds and complete peace of mind that they have our affairs in order.
Both businesses are very helpful, friendly, informative and cooperative.
Graham & Lynny Ingles
“Making the decision to start my own business meant I needed to seek professional business advice. McHenry Partners were able to advise me on the right entity to use, guide me on compliance matters I needed to navigate, set us up on Xero and provide training on the software (which we have found to be a breeze to use) and answer all our questions.
It certainly helps getting our business off on the right foot with no unwanted surprises to occur.”
Ben Mitchell
Stinton Advisory
“We had only been in business for 18 months and growing at a quick rate but felt we needed a mentor or coach to provide more guidance to address the ‘growing pains’ we were experiencing. Our existing accountant had prioritized a compliance focus. By moving across to McHenry Partners they were able to point out improvements to our credit policies, train us on a better financial management system and guide us on the working capital we required to support our growing business. Also introducing us to their associates to help us in areas of expertise, such as asset finance.
I am feeling more in control now and confident we can sustain our growth to achieve even better financial returns.”
Andrew Palmer
Surfcoast Cabinets
The Tax Consequences
Negative gearing of a rental property can be complex. For example, some expenses are not deductible (stamp duty, initial repairs etc.) while other expenses such as borrowing costs and depreciation are generally claimed over a number of years. As such, the right taxation advice can nearly be as important as finding the right property.
To broadly illustrate how negative gearing works let’s assume you buy a flat or unit for $400,000 in your personal name and borrow $350,000 to fund the purchase. The funds are borrowed at an interest rate of 8% and the weekly rent is $450 or $23,400 a year. Ongoing costs including agent’s fees at 7% of the rent, rates, insurance, repairs and maintenance and other expenses are summarised below:
Supporting Businesses & Individuals Across Greater Geelong
We work with clients throughout Geelong and surrounding suburbs, including:
- Geelong
- Newtown
- Belmont
- Highton
- Waurn Ponds
- Grovedale
- Armstrong Creek
- Charlemont
- Torquay
- Jan Juc
- Ocean Grove
- Barwon Heads
- Leopold
- Drysdale
- Clifton Springs
- St Leonards
- Lara
- Corio
- Norlane
- Bannockburn
Sample Property Profit & Loss Statement
Sample Property Profit & Loss Statement
| Rental Income – 52 Weeks @ $450 Expenses – Interest – $350,000 @ 8% – Water Rates Council Rates – Insurance – Repairs & Maintenance – Agents Commission – 7% of $23,400 – Bank Charges – Body Corporate Fees TAX LOSS |
$ 28000 968 1282 900 600 1638 12 1000 ——— |
23400 34400 ———- $ 11000 |
This relatively simple example suggests, after expenses the net income for the year will be $17,000 ($23,400 minus $6,400), equivalent to a net rental yield of 4.25%. However, annual interest repayments are $28,000, so the tax deductible loss is $11,000 for the year ($23,400 minus $34,400 = -$11,000).
Assuming you own the property in your own name, the loss will reduce your taxable income by $11,000 and if you had a taxable income greater than $180,000 in the 2012 financial year, the after tax cost of owning the property would only be $5,885 or $113.17 per week (based on a marginal tax rate of 46.5%). If you were on a lower marginal rate of tax of say 31.5% (including Medicare levy) the after tax cost would be $7,535 (or $144.90 per week).
How We Can Help You …
When buying an investment property we can assist you in several areas:
- We have a comprehensive booklet available to clients, ‘The Complete Guide to Negative Gearing & Property’ that explores what expenses are deductible, what costs need to be apportioned and which costs are non-deductible. It explains how negative gearing works for tax purposes and what costs form part of the cost base for capital gains tax purposes. It guides you through what we describe as the 13 steps of negative gearing and is available free of charge to our clients in conjunction with a negative gearing consultation.
- Evaluate the tax consequences – Using an intelligent software tool we can prepare a 10 year cash flow analysis of the proposed property, taxable income forecasts and equity projections. This ‘what if’ analysis let’s us quantify the financial impact of changes in key variables such as rental income or mortgage interest rates.
- Where to buy – through the services of a buyer’s advocate we are able to help you locate the right property in the right location with a view to maximizing the capital gain on sale.
- Finance – through our affiliation with a mortgage broking group we can help you find the ideal loan that is correctly structured for taxation purposes.
- The tax loss on the property can pose a major cashflow issue, however, we can prepare an application to vary your PAYG tax withholding so that your annual tax deductible loss is reflected in your regular pay packet.
- Historically we have found the calculation of capital gains on sale of property to be a source of major headaches and frustration due to the loss of source documents. We can make recommendations regarding your record keeping including recording cost base details for capital gains tax purposes.
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