Negative gearing explained

If you have equity in an existing property, cash to invest or you're looking to enter the property market for the first time, you've probably heard of negative gearing.

With the correct financial advice, and the right property, negative gearing can be a positive investment decision. Read on to find out more about negative gearing.

An investment property is negatively geared when the costs of owning it - interest on the loan, bank charges, agent fees, maintenance, repairs and capital depreciation - exceed the income it produces (rent).

Negative gearing offers immediate tax benefits coupled with the longer term prospect of an increase in investment value. For these reasons it's a more common choice for property speculators and/or those with hefty tax obligations.

Your investment must make a loss before you can claim a tax benefit. This not only works for property, but also shares, bonds and other investments.

Investment property owners can claim deduction and depreciation against income on the property. There are three main classes of deductions available to investors:

1. Revenue deductions - these include interest on the loan as well as ongoing maintenance and recurrent expenses such as agent fees, council fees, advertising charges, bank fees, body corporate fees, cleaning expenses, gas, water, gardening and insurance.
2. Claims for capital items - large capital items such as a hot water service, white goods, etc. are subject to depreciation. This means the owner must claim the cost over a number of years rather than all at once. Depreciation schedules are set by the Taxation Department and range from a few years to more than 20 years.
3. Claims for building allowances - owners can also claim depreciation of capital works, specifically for building and landscaping. The current rate is 2.5% over 40 years.

Effective negative gearing relies on the value of the investment increasing over time. Real Estate Institute of Australia research shows that over the past 20 years house prices have increased on an annual average basis by 8.3 per cent.

Like all investment strategies, investors must consider the inherent risk associated with borrowing money for an investment. The borrowers should consider their capacity to repay the shortfall and continue servicing the investment loan should it cease to make a return if the tenants leave or for other unforeseen circumstances.

An example negative gearing scenario is shown in the table below.

Example of negative gearing

This example demonstrates how an investment asset may be negatively geared. The net loss of $890.00 per month ($10,680.00 per annum) may be claimed as a tax deduction.

To find out more about negative gearing and your loan options for an investment property, visit Lendi.com.au and chat to a specialist.