Negative Gearing Calculator

What is negative gearing?

Negative gearing, a prominent feature of the Australian taxation landscape and a frequent topic of debate among economic commentators, involves owning an investment property where the rental income does not cover the costs of ownership.

For example, if an investor receives $20,000 in rental income but pays $25,000 in expenses for the property, they incur a $5,000 loss. This loss can be offset against the investor's other taxable income, such as salary or profits from other investments, effectively reducing their taxable income and resulting in tax savings.

Despite seeming unappealing due to the ongoing financial loss, negative gearing can be strategically advantageous. Investors may expect property values to appreciate over time, potentially outweighing the costs and leading to substantial capital gains. The Australian taxation system allows for deductions of various expenses, such as home loan interest, property management fees, repairs, and rates, as well as depreciation on the rental property.

For instance, if Ernie earns $100,000 annually and incurs a $10,000 loss on his investment property, he can reduce his taxable income to $90,000, thereby saving on income tax.

However, there are risks, as negative gearing means continuously losing money and requiring careful budgeting for the shortfall. Nonetheless, the ability to claim tax deductions on these losses and the potential for capital growth are significant benefits that can outweigh the associated financial losses.

How to calculate the tax implications of your negatively geared property

Calculating the tax implications of a negatively geared property is a complex process involving several steps.

First, you need to tally up all the income and expenses associated with the property. This calculation also depends on your other taxable income, which determines the marginal tax rate applied.

To calculate the impact of negative gearing on your taxable income, sum all eligible expenses incurred in the tax year, subtract any rental income earned, and then deduct the resulting figure from your total taxable income. This adjusted income is then used to assess your tax liability based on your marginal tax rate.

Alternatively, you can use a calculator (such as ours!) to input your income and investment property details, which will automatically compute the tax implications for you.

Benefits of negative gearing

Negative gearing offers several benefits to property investors, primarily through its impact on tax liabilities and potential for long-term financial gains.

Ability to offset rental property losses against other taxable income: This means that if the costs of owning and maintaining a rental property exceed the rental income it generates, the investor can deduct these losses from their overall income, thereby reducing their taxable income. This can result in substantial tax savings, making the financial burden of property ownership more manageable, especially in the early years when rental income might be low, and expenses high.

Potential for capital growth: Property values tend to appreciate over time, and a strategically purchased property in a desirable location can experience significant value increases. Even though the property might be operating at a loss in the short term, the long-term appreciation can more than compensate for these losses. When the property is eventually sold, the capital gains realised can represent a substantial financial return on investment. This potential for capital growth makes negative gearing an attractive strategy for investors who are focused on long-term wealth accumulation.

Flexibility in financial planning: By reducing taxable income through property-related losses, investors can improve their cash flow management and allocate resources more effectively. This can be particularly beneficial for high-income earners who face higher marginal tax rates, as the tax savings from negative gearing can be significant. Additionally, negative gearing can be used in conjunction with other investment strategies to diversify an investor's portfolio, spreading risk across different asset classes while still enjoying the tax benefits associated with property investment.

Opportunities to invest in higher-quality properties: The tax benefits help to offset the costs of owning premium properties, which tend to appreciate more over time and attract higher rental yields. This can lead to a higher overall return on investment, as both the rental income and the capital appreciation are likely to be greater for well-located, high-quality properties.

What expenses can be considered when negative gearing?

When considering expenses for negative gearing, it's important to understand both the allowable and non-allowable deductions. Negative gearing allows investors to deduct a variety of both regular and irregular expenses associated with owning an investment property. These deductible expenses include council rates, property management fees, and depreciation. Investors can also deduct costs for repairs, unexpected maintenance, and advertising fees.

Additionally, the value of fixtures and fittings (referred to as plant and equipment in tax terms) and the wear and tear on the building itself (known as capital works) can be depreciated. However, certain expenses are not deductible. The cost of the actual property and the portion of home loan repayments that go towards paying down the mortgage principal cannot be deducted. Only the interest portion of the mortgage repayments is deductible, which is why many property investors opt for interest-only home loans.

By deducting the interest and other allowable costs, investors can negatively gear their property, potentially lowering their taxable income. When the property is sold, they hope to profit from the capital gains. It's important to note that an investor can only offset their income by the amount of their net loss, not by the total expenses. For example, if a property generates $15,000 in rental income but incurs $16,000 in expenses, the investor can claim a tax deduction for the $1,000 net loss, not the entire $16,000 spent.

Here is a non-exhaustive list of expenses that may be considered when negative gearing:

• Interest portion of home loan repayments
• Lenders mortgage insurance (LMI)
• Stamp duty
• Advertising and property management fees
• Depreciation of plant and equipment, and capital works
• Council rates
• Insurance
• Repairs and maintenance

Is negative gearing right for your property investment strategy?

Negative gearing, while offering some short-term tax advantages, is generally not considered a sound long-term investment strategy by most experts.

Initially, investment properties often don't turn a profit, leading investors to make a loss that can be offset against their other taxable income, thus reducing their overall tax liability. However, the fundamental issue with negative gearing is that it inherently involves making a loss on the investment.

For instance, if an investor incurs a $2,000 loss from negative gearing in the financial year 2024/25 and their taxable income falls between $45,000 and $200,000, they would save approximately $600 in taxes. This tax saving is due to the 30% tax rate applied to their income bracket. However, they would still have to bear the remaining $1,400 of the loss themselves.

This approach can significantly impact cash flow and is designed more to encourage property investment by minimising potential losses rather than ensuring long-term profitability. Some investors hope that the initial losses will be outweighed by future capital gains when the property appreciates in value. However, this strategy is risky as it relies on the assumption that property values will increase, which is not guaranteed. Fluctuations in interest rates can also affect the deductions and overall cash flow, making this strategy even more uncertain.

When deciding if negative gearing is right for your property investment strategy, it's important to consider various factors, including your total annual income, the ongoing costs of the rental property, and the amount of interest paid on the home loan. Higher-income investors might find negative gearing more appealing as it can substantially reduce their tax bill, but it's important to note that tax deductions will never completely offset the investment losses.

In Australia, the maximum tax rate, including the Medicare levy, is 47%, meaning a negatively geared investor can only reduce their tax by 47 cents for every dollar lost. Many investors find positively geared properties more beneficial in the long run as they increase cash flow, improve borrowing power, and potentially allow for extra loan repayments. These benefits can enhance equity, reduce total interest paid, shorten the loan term, and accelerate the purchase of additional properties, leading to a more robust investment portfolio.

About our Negative Gearing Calculator

The Negative Gearing Calculator is designed to give residential property investors an estimate of the net income effect of owning an investment property. The calculator combines the cash operating revenue, rent, and the cash operating expenses, with the change in the amount of income tax paid to measure the net change in the investor's income due to the investment property.

Assumptions

When calculating the "Change in tax paid" only the marginal tax rates applicable to Australian residents are used. The calculator does incorporate the Medicare Levy of 1.5 percent but does not take any other factors which can influence the amount of tax paid, such as HECS contributions, any rebates, deductions or levies into account.

Building allowance is calculated for investment properties constructed after 18 July 1985. For buildings where construction began between 19/7/1985 and 15/9/1987 the building allowance is 4 percent of the construction cost, for 25 years after construction. For investment properties where construction began after 15/9/1987 the building allowance is 2.5 percent of the construction cost, for 40 years after construction.

Depreciation is calculated using the prime cost method. The following effective lives and depreciation rates are used:

The calculator does not take any additional laws relating to depreciation into account. For example, it is possible to treat items under $300 as expenditure and claim the full amount in the year of purchase. However, the calculator does not apply this rule, it depreciates the asset over its effective life.

Explanation of Terms

Annual Rental Income: Annual Rental Income is the rental income you receive for the year. It increases each year by the growth rate input in Potential Rental Growth per annum.

Annual Loan Repayments: Annual Loan Repayments is the total of loan interest payments for the year. It is assumed the loan has interest only payments.

Annual Cash Operating Expenses: Annual Cash Operating Expenses is the total of the tax deductible expenses associated with the property for the year. It increases by the growth rate input in Estimated Operating Expenses Growth per annum.

Cash Flow: is the cash revenues less the cash expenses. That is Annual Rental Income less the Annual Loan Repayments and Annual Cash Operating Expenses. This measures the amount of cash you will receive, if it is a positive number, or the amount you will have to pay over the year if it is a negative number.

Annual Depreciation: Annual Depreciation is the sum of the depreciation for the year based on the depreciable items entered. It is calculated using the prime cost method rather than the diminishing value method. For more information about how depreciation is calculated see the about page.

Building Allowance: Building Allowance is the tax deduction which can be made for this property. The rate at which building allowance can be claimed is determined by when the property was built.

Annual Tax Profit/Loss on Property: Annual Tax Profit/Loss on Property combines the cash flow generated by the property with the tax deductions to determine the profit or loss for accounting purposes. As depreciation and building allowance reduce taxable income, the profit or loss for accounting purposes will be lower than the cash flow generated.

Change in Tax Paid: The Change in Tax Paid measures the change in the amount of income tax the investor pays due to owning the investment property, compared to if they did not own the property. This is calculated based on the annual taxable income from other sources entered by the user. If the Change in Tax Paid is negative it means the user pays less tax. If it is positive it means the user pays more tax, relative to if they had not owned the investment property.

After Tax Profit/Loss on Investment: The After Tax Profit/Loss on Investment combines the cashflow associated with the investment property with the tax effect of owning the investment property to measure the net effect of the investment. A positive number indicates a profit, a negative amount indicates an after tax loss.

Note: the Negative Gearing Calculator is a guide only and should not be considered investment advice. Before taking out a margin loan you should consult your financial advisor.