Negative gearing is a commonly used term and lots of Australian property investors are doing it, but what exactly is negative gearing? Negative Gearing is when you borrow to acquire an investment and the interest and other costs you incur are more than the income you receive.
Negative gearing of investment property in Australia is used as a means to make it easier to hold property and let it grow in value over time. Sydney, Melbourne and Brisbane property investment groups have for many years used negative gearing and it's benefits as and advertising headline in promoting property investment.
In terms of property investment negative gearing in Australia and New Zealand refers to a situation where your expenses to maintain an income-producing property exceed the income of the property itself. Positive gearing of an investment property refers to an excess of income, over and above any expenses. The ultimate aim for most smart investors being a portfolio of positively geared properties. Initially however, it is through negative gearing and the associated tax benefits that investors are able to purchase real estate at minimal cost to themselves. The difference between the amount of rent from your property and the expenses related to the property are (assuming there is a loss) tax deductible.
There is also provision for non-cash expenses, for example depreciation on items such as light fittings, carpet, building costs, etc. which may increase your available deductions. The important words are "Tax Deductible". Below is an overview of these deductions and how the investor is able to take advantage of them to create their own real estate portfolio.
Deductions on Purchasing Costs
- Tax deductible over 5 years
- Valuation Fees
- Stamp duty on Mortgage
- Bank Application Fees
- Mortgage Insurance
- Consultancy Fees
- Building Costs (2.5% p.a. over 40 years)
- Fixtures & Fittings
- Inspection Costs
- Other acceptable costs (as per tax schedule)
Calculation of depreciable items is much specialised, the above figures are indicative only, it is recommended that the services of a Quantity Surveyor be used to ensure you maximise your depreciation deductions. Investors should also use an accountant who specialises in property investment to ensure all tax deductible items are claimed. There are many factors to consider when selecting your property and one of them is new or existing. The answer is new. This is to maximise your tax advantages and to reduce the out of pocket costs to yourself to fund the property.
Australia and New Zealand governments introduced negative gearing in the early 1980's as an initiative to encourage income earners to purchase investment property to enhance the availability of rental property. Even more importantly negative gearing and subsequent increases in property development promoted industry and development within the economy. Many industries within the economy rely on building and development. Not just people employed directly, but also factories etc. who make the products used by builders and developers (this factor had been emphasised in 2001 with the Federal Government's increase of the first homebuyers grant to $14,000, now reverted back to $7,000)
Another advantage to governments is the relief of pressure to supply and maintain housing for people who are not in a position to purchase their own home, thereby saving millions of dollars in funding plus huge administration and infrastructure costs. Further to this point, approximately 34% (and growing) of the population rent. An under-supply of rental property would not only push rents up (giving rise to inflationary pressure and unhappy electorates), it would also put further pressure on the government housing supply.
To encourage the private sector to invest in property for rental, governments have made available extremely viable tax incentives for the investor. It is through these available tax incentives that investors are able to purchase property at very little cost to themselves and in many cases at virtually no cost to themselves.
Simply put: the tax man and the rental income pays for your investment property!!