If you’ve been considering buying a property recently, no doubt you’ve had your eyes keenly glued to the evening news for budget announcements. There has been much debate, on both sides of the political spectrum, about the merits or otherwise of negative gearing. Unfortunately, there are a large contingent of the home-buying public who simply don’t understand this complex issue. And that can mean undue stress when purchasing an investment property. Understanding negative and positive gearing can help you to make the most informed property-buying decisions, and will ultimately increase your chances for real estate success.
What is negative gearing?
Negative gearing involves structuring your investment so that your outgoings (costs associated with maintaining a property, including the interest on your loan repayments) are greater than the income you receive from renting the property out. Often, investors will choose to negatively gear a property in order to bring down their taxable income. This kind of investment can make it easier for many people to enter the property market, and it is a popular choice for many new investors, particularly as their deposit is smaller. In the 2012-13 tax year, around 1.2 million people owned negatively geared properties in Australia, and that figure has since risen significantly.
What is positive gearing?
Positive geared property is where most investors hope to end up. Positive gearing involves making a net income from the rental return of your property, as it outweighs the costs associated with maintaining the property, and the servicing of the loan. Long-term investors who wish to grow their portfolio will hope to have their properties positively geared eventually, so that they are making an income from their investment.
Negative gearing is not, should not be, used as a property investment strategy.
Instead, by negatively gearing, most investors hope to be able to maintain a loan on their investment property with reduced stress on their taxable income; until such time as the property is positively geared, or they are able to access the equity in their property to refinance or sell for a profit.
Common misunderstandings about negative gearing
There is a lot of controversy in Australia at the moment surrounding the property market, and the effects of negative gearing on housing affordability. Negative gearing is seen by some as a way for wealthy investors to skew their taxes in a way which benefits the bottom line. Some media outlets would have you believe that negative gearing single-handedly raises the price of housing around Australia, and makes it harder for first-time buyers to enter the market.
In actual fact, many people across the income spectrum negatively gear. While the percentage of negatively geared properties is higher among high-income earners, there are a large contingent of ‘Mum and Dad’ investors who choose to negatively gear, in order to invest successfully.
The average tax saving as a result of negative gearing in Australia is around $1,800, and it is expected that by 2018 the median income of investors who negatively gear will be approximately $69,900 annually. While this kind of annual income is higher than that of the remaining population, it is clear that negative gearing is not the reserve of the extremely wealthy.
As Treasurer Scott Morrison explained in his recent budget announcements, nearly two thirds of negatively geared properties in Australia are owned by landlords with an income of $80,000 or less. In fact, one in five police officers own a negatively geared investment property, so too do as many as 58,000 teachers.
What figures such as these highlight is that everyday investors play a huge role in supplying rental housing to the Australian rental market, and that reducing tax payable is unlikely to be a major motivation. Most investors buy in to the property market in order to positively gear, that is, to make a profit from their investment. Despite some popular opinion, most investors do not buy property simply to offset their taxable income. Property investment is a long-term strategy for growing wealth—among the wealthy, and the average household alike—and not merely a tax-reduction strategy.
How do the budget announcements affect you?
Despite a lot of talk about abolishing or restricting negative gearing in the lead up to the newest federal and state budget announcements, both levels of government have opted to leave much of the current policies as they stand. Instead, in an attempt to tackle housing affordability, both the NSW state government and the federal Liberal governments have made some changes which they hope will encourage new developments and restrict some foreign investment.
There is some good news for first home buyers, as stamp duty is set to be abolished on properties valued up to $650,000, so too is the 9% stamp duty on LMI (Lender Mortgage Insurance). On the other hand, the budget has put a stop to the 12-month stamp duty deferral for ‘off-the-plan’ properties bought by investors. Meanwhile, stamp duty and taxes for foreign investors have been increased. The number of properties in a new development which can be purchased by foreign investors will be limited to 50% (a reintroduction of a previous policy). While this could limit the ability of developers to fund new projects, it is hoped that this will encourage home-grown investment.
Further changes include the restriction of taxable expenses on negatively geared properties, including the abolishing of deductible travel expenses and a tightening of depreciation of plant and equipment assets. Meanwhile, expenses incurred through the engagement of third parties, such as real estate property management fees, are still deductible.
These measures are designed to make it easier for first home buyers to compete in the property market, and makes things slightly more difficult for some: namely for foreign investors. Despite this, investment, and negative gearing are still attractive strategies for both would-be first-time Australian investors and seasoned experts.
How negative gearing can help you to enter
the property market
While in the last month, some capital cities such as Sydney have seen a slight cooling in the housing market, the past 12 months have seen some excellent growth. Sydney housing prices increased by 11.1% year-on-year in May, and total gross returns for the last 12 months sat at 14.5%. While the growth rate moves each year, it is clear that property prices continue to grow steadily. This is, of course, good news for those wishing to invest. Whether you hope to hold on to your investment property for rental income over the long-term, or to purchase and sell on the property in order to make a profit, investment opportunities in Sydney and many other major cities are promising. It is worthwhile keeping in mind that capital gains tax (CGT) may apply to the profit you make on the sale of your property in the future, and that the concessions applicable to capital gains is likely to vary depending on government policy.
Negative gearing can help you to offset the cost of your new investment property by lowering your taxable income, and thus lowering your tax payable. This is especially helpful for those who are new to the property investment market, and do not have a large amount of cash to lay down as a deposit on their property purchase. The higher the interest you pay, the more you are able to offset this against your income, and reduce your overall expenses.
For example, if you purchase an investment property which rents for $500 per week (assuming it is tenanted for the entire financial year), your rental income would amount to $26,000.
Your deductible expenses for the property may total, for example, $40,000 (including interest on the loan). Your total loss on the property is $14,000 for the year. You can now deduct this loss from your taxable income for the year, effectively lowering the amount of income tax you will pay.
While there is still much debate around the benefits or otherwise of negative gearing on the Australian housing market, it is clear that both state and federal governments are at pains to allow everyday investors to remain in the market. Negative gearing represents an opportunity for investors hoping to enter the market with minimal upfront costs, and remain in the market by reducing their tax, until such time as their investments begin to reap the benefits of increasing values.