Important Information About Negative Gearing
It is highly likely that you have come across the term “negative gearing” in relation to the investing of a property. When it comes to investing, the term 'gearing' refers to borrowing to buy an asset. It is generally a way of describing borrowing to invest. This means that if you take out a loan to buy a rental property, your investment is said to be geared.
A large number of investors use some gearing in the form of their mortgage, to fund their rental property. Gearing however can in many cases be a bit confusing though, so it’s important to make an effort to do some research on the topic so that it can be better understand so that you can apply it strategically to your investment strategy.
Negative gearing happens whenever the cost of owning a rental property outweighs the income it generates each year. This generates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.
There are plenty of benefits that can be accumulated by negatively gearing a property. For example; if a person owns a rental property that generates $25,000 in rent every year. The costs of holding the property, including mortgage interest, come to $30,000. This gives the property owners a taxable loss of $5,000, which the property own can use to reduce the tax payable on their salary.
If you know in advance that your investment will record a loss over the financial year, you can apply to the Australian Tax Office (ATO) to reduce the amount of tax taken out of your salary. This is called PAYG Withholding Variation and it can provide a real boost to your personal cash flow. You can chat with your mortgage broker about options and with a tax adviser or accountant for more details.
Negative gearing investment properties in many cases often plays a huge role in all investors’ strategies. Having a solid understanding of your investment strategy is important, and getting expert financial advice is smart if you need help identifying the right approach to ensure that you maximize your profits.
In comparison positive gearing occurs when an investment property earns more in rental income each year than it costs to own the property. For example; A landlord may receive $20,000 in annual rent but only spend $15,000 on the property including mortgage interest. In this type of scenario, the difference of $5,000 represents profit and additional income to the landlord. As this profit is taxable, landlords of positively geared properties need to set funds aside to cover the tax they will pay on their investment each year.
Although there are plenty of benefits associated with negative gearing it is also important to be aware of the many risks associated with it.
Whenever a person negatively gears their property, they still record a loss. Ultimately a loss is a loss is a loss. Before you commit to negatively gearing your investment property or perhaps multiple investment properties it is super important to take into consideration what the repercussions of doing so are.
• What happens if you have difficulty filling your rental property at any one time?
• What if there is a dramatic turn down in property values and your investment fails to increase in value?
• What if interest rates rise very quickly and you have just agreed with your tenants that you will not raise rents for at least 12 months?
These questions need to be taken seriously and answered appropriately. You need to take some time to do your due diligence and know how you would cope if any of the above scenarios came true. If you are confident that you could easily handle any losses in income and so on, then you are on the right path.
Of course, if you do choose to negatively gear your property, there are some easy ways for you to minimize the risks associated with doing so.
Here are some tips on how to reduce the risks associated with negative gearing.
Choose Your Investment Property Wisely - Buying a property that is located near all the major amenities and appeals to a wide range of tenants should help you to ensure your investment property is never vacant for very long.
Manage Your Income - When managing an investment property, there are times when it will cost you a significant amount of money – when the property is vacant, when it needs repairs and so on. This means that it is important that before you decide on negative gearing make sure you have enough income to successfully manage all the expenses that come with owing a property not just day to day expenses, but all of the expenses.
