Imagine that you have just bought a house or flat, with the intention of renting it out. You have a mortgage to pay on it every month. You have found a renter, but the income from rent is less than you need to spend in mortgage payments or other expenses such as property repairs and maintenance. Instead of making a profit, you’re losing money and it’s a disaster, right? Not necessarily. In fact, there is an established way to turn a negative investment situation into a positive one, by using negative gearing.
What is negative gearing?
“Negative gearing” has become a buzzword in the property investment market, but the concept can be a little confusing if you’re not an experienced investor or accountant. It essentially involves taking a short-term financial loss on your investment; you lose cash on an immediate basis, although the overall value of your property may continue to increase. You can also set up your taxes in such way as to offset the loss. Consider negative gearing in contrast to “positive gearing” which involves making a cash profit on your investment or “neutral gearing” where you break even.
The benefits of negative gearing
Initially it may seem risky and even foolish to accept a financial loss, but there are a few ways that negative gearing can help you.
- Recoup your loss by reducing income tax: In order to mitigate any financial loss, property investors are able to offset lost money against their taxable income in order to pay less tax. If you know in advance that you will be negative gearing, you can contact the Australian Tax Office and ask them to reduce the amount of tax taken from your salary, using the ‘PAYG Withholding Variation.’
- Other tax savings: When negatively gearing, there are a wide range of deductions you can make, such as claims on gardening, body corporate fees, advertising for tenants, land tax, insurance and so on.
- Short-term loss for long term gain: One of the main reasons for investing in property is the hope that the value of the property will increase over time. Taking a short-term loss is a legitimate investment strategy if you foresee a large capital gain on your investment, with the intention of making a profit when you sell the property in the future.
While negative gearing is a sound investment strategy, it needs to be carefully managed in order to achieve successful results. Contact us for advice on negative gearing, positive gearing or managing your investment property.