The what, why and how of negative gearing
Negative gearing is a rising trend among investors. People who want to purchase investment properties often need to borrow money from lending institutions. When people borrow, they calculate the risks and potential rewards carefully. Most ordinary investors will try to ensure the monthly profits from their investment property will surpass the mortgage repayments and interest rates.
Negative gearing doesn’t follow the same rules. People borrow money knowing that the profits from the property won’t cover the monthly interest and mortgage repayments. Investors make up for the shortfall between the interest payments and income earned with the help of deductions from their current income tax. Negative gearing is prevalent in Canada, Australia, and New Zealand because of the tax policies and concessions in these countries.
Why would you invest in a property that doesn’t offer profits that actively cover your expenses? Even if you get a tax break from the government, you don’t earn enough profit through rent to justify the initial investment. Here’s what you need to understand about negative gearing:
Negative gearing is a financially sound decision only if your capital gains are greater than your initial investments and related expenses.
You need to consider a number of factors before you invest in negative gearing. If you don’t plan your investment well, you can face losses amounting to several thousand dollars. Here’s what you need to consider:
All of these factors will help you determine the capital gains from your investment. If you don’t perform these calculations, you won’t know if the property is worth investing in and whether you will get enough money to justify the investment. This is how negative gearing works and delivers profit. It relies solely on the market demand and supply as well as the growth in property rates.
An example of negative gearing
It’s not easy to understand how negative gearing works without considering a real-life example. Here is an example that illustrates how you can earn profit using this investment strategy:
If the value of the property doesn’t grow by 10% or more, you won’t gain enough profit to justify your investment.
In most cases, you can claim a deduction for any expenses related to the management and maintenance of an investment property, this includes any interest you pay on loans. When your asset is negatively geared, you may be able to deduct the full amount of rental expenses against your rental and other income, including your salary and wages.
The rule of thumb is, property investors can claim deductions in three main categories:
The 2021 budget includes a number of measures relevant to property investors, however it doesn’t directly address or change existing arrangements around negative gearing.
Negative gearing is still a good investment option for Australians, particularly if you have enough financial stability to support the shortfall between the interest rates and the income generated. The housing market is on the upward trend so you can expect the value of the property to grow comfortably over a short period of time.
It’s a good idea to consider a short-term investment instead of long term investment if you intend to use negative gearing. Most people only invest for one year and see several thousand dollars in profit. This can keep you safe from any changes to regulations the government makes in future years.
The Oneflare Cost Guide Centre is your one-stop shop to help you set your budget; from smaller tasks to larger projects.