Earlier in 2019, investors became worried after Labor proposed to make substantial changes to negative gearing changes. They didn’t win the federal election, but the proposed alterations sparked discussions among different sectors and have put negative gearing on the spotlight.
In an interview with Chan & Naylor Founder Ed Chan, Your Investment Property editor Sarah Megginson revisits the concept and asks about the most important points that property investors should know.
What is negative gearing?
Negative gearing is when you buy an investment property, and the outgoings that you pay on the loan to buy the property are greater than the rent itself. Outgoings refer to expenses like water rates, council rates, repairs, and the interest.
“It is negative, meaning that you are behind from the outset. Therefore, you have to supplement that negative gearing with another source of income, and generally, for most people, it is their wages. It is what they rely on to fund the negative gearing,” he says.
“You would not be able to keep or hang on to that property unless you fund the shortfall.”
Chan added that when you are claiming deductions against your investment property, the principal of the loan is not tax deductible – only the interest component is. This is because when an individual first receives the money from the bank, it is not taxed.
“You do not pay tax on that principal when you first receive it. So, when you pay [the principal] back in a lump sum, or you pay it by a monthly amount, you cannot claim that as a tax deduction,” he tells Your Investment Property.
“You generally only get a tax deduction if it is taxed on the other side so, you can’t have it both ways. If you receive the money and the tax department taxed you on that, then the repayment of it will then be tax deductible,” he told.
Checking your goals when holding negatively-geared investments
Chan reminds investors that they should never invest for tax.
“Often people will say ‘Oh, I’m saving tax on this so I’ll go and buy a property’. That should not be a reason why you invest. The reason that the tax refund is good is because it reduces the cost of holding the property, and the thinking behind it is if I have got to pay a thousand dollars a week in tax anyway, then if I go into a negatively-geared property, I can redeploy some of that money into the property instead of sending it all to the tax man,” he said.
“However, unless you have the means of funding the additional shortfall, then you should not go into something just for the tax purposes.”
People invest in negatively geared properties in the hopes that the capital gain will be higher than the accumulated losses of the property over the lifetime of holding a property.
“Property is like all investments. It is a risk. However, in real estate, it is a lot safer because there is a history of growth in real estate and it is a lot more reliable than any other sort of investments,” Chan said.