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Gearing Your Investment Property – How to Get it Right

Gearing Your Investment Property – How to Get it Right

You may have heard the terms ‘Positive Gearing’ and ‘Negative Gearing’ regarding property investment when speaking to your mates around the barbecue or chatting with co-workers in the lunchroom. It often causes intense debate and confusion, particularly when everyone has different circumstances and goals. So how do you make the most of gearing? In this article, we will help you distinguish between the two, outline the advantages and disadvantages of each, and explain how it can work for you.

Positive vs Negative Gearing

In order to demystify gearing as a topic, let’s first understand the different between positive and negative gearing. Positive Gearing is when your deductible expenses are less than the income you earn from the property and resulting in a net rental profit. This net rental profit is then added on top of your other income such as wages, salary and/or business income and subject to your marginal tax rate. Negative Gearing occurs when your deductible rental expenses are more than the income you earn from the property resulting in a net rental loss. This rental loss may then be able to be used as a tax deduction against your other income such as wages, salary and/or business income.

Gearing – What Should I Be Working Towards?

To be clear from the outset, the ultimate goal in investing (whether it be in property or shares) is to be positively geared – as that is when you are making money on your investments. With the Reserve Bank cutting interest rates over the years, great opportunities exist for people to achieve positive gearing. When you first invest in property it is likely that the investment will be negatively geared due to interest on loans, depreciation and other expenses. However, as your debt reduces over time (assuming you’re paying principal as well as interest), you will progressively work towards positive gearing, in which the property is paying for itself.

There is, sometimes, a misconception that negative gearing is the aim because of the tax incentives it can provide. However, to put it into simple terms, why would you spend $1.00 to save $0.30? Also, a long-term negative gearing investment strategy relies heavily on property values rising – reinforcing the importance of seeking professional property advice.

Gearing – Case Studies

Taking all of the above into consideration, negative gearing can be a good thing if it’s done right, it works towards positive gearing, and it fits in with your overall investment strategy.

Below are 3 case studies with similar facts to demonstrate positive gearing and negative gearing along with the relevant tax implications:

Case Study 1: Positively Geared

  • Your taxable income for the year is $90,000
  • Your investment property is worth $500,000 with a $400,000 loan.
  • Your loan is interest only at 2.60% or $10,400 for the year.
  • Rental income is $400 per week ($20,800 per annum).
  • Rental expenses such as council rates, repairs and other costs total $7,000 per year.
Rental Income $20,800
Interest expense on loan $10,400
Other expenses $7,000
Net profit on rental $3,400

The likely tax impact on this positively geared investment is an additional tax liability of $1,275 inclusive of Medicare Levy and tax offsets. As a result, your net cash position is $2,125.

Case Study 2: Negatively Geared

  • Your taxable income for the year is $90,000
  • Your investment property is worth $500,000 with a $400,000 loan.
  • Your loan is interest only at 2.60% or $10,400 for the year.
  • Rental income is $400 per week ($20,800 per annum).
  • Rental expenses such as council rates, repairs and other costs total $12,000 per year.
Rental Income $20,800
Interest expense on loan $10,400
Other expenses $12,000
Net loss on rental ($1,600)

The likely tax impact on this negatively geared investment is a $552 refund due to the loss acting as a tax deduction against your taxable income. As a result, your net cash position is -$1,048 despite the tax refund, as you are still physically out of pocket on the rental expenses.

Case Study 3: Negative Gearing but positive cash flow

  • Your taxable income for the year is $90,000
  • Investment property is worth $500,000 with a $400,000 loan.
  • The loan is interest only at 2.60% or $10,400 for the year.
  • Rent is $400 per week ($20,800 per annum).
  • Rental expenses such as council rates, repairs and other costs total $7,000 per year.
  • You purchased a quantity surveyor’s report that advised you can claim $5,000 in depreciation.
Rental Income $20,800
Depreciation $5,000
Interest expense on loan $10,400
Other expenses $7,000
Net loss on rental ($1,600)

The likely tax impact on this negatively geared investment is a $552 refund (similar to the above). The difference being that depreciation outlined on quantity surveyor’s report is wear and tear on the property, classified as a non-cash expense. As a result, your net cash position is $3,952 despite being negatively geared for tax purposes but overall, you’re not physically out of pocket on the rental expenses.

As you can see from the above, how your property is geared has a significant impact on the bottom line with a difference of $3,173 of additional cash just between case studies 1 and 2. While negative gearing does create tax incentives in the form of additional deductions, it may not be sustainable if it is a long-term strategy and property values aren’t increasing.

The Bottom Line

It’s worth noting that the Reserve Bank generally cuts interest rates to stimulate the economy, often coinciding with lower property values. As a result, while interest rates are lower it is an excellent opportunity to reduce your debt if you have some spare cash available, so that the increasing cost of owning the property is minimised when interest rates eventually rise. This means that down the line, if property values have increased and you’re in a position to sell, you have put yourself in the best position to maximise your return on investment.

If you are considering in investing in property and want to know the best way to go about it (particularly from a tax perspective), please contact us today to see how we can assist. Give us a call on 08 9301 2200 (Joondalup) or 08 9361 3300 (Victoria Park) – alternatively, you can get in touch via our website. We look forward to seeing how we can help you make the most of your property investment journey!

Also, keep an eye on our website and social media pages for information about our upcoming property webinar…

Please note the information provided within this article is general of nature and is not a personal advice recommendation. Prior to considering strategies discussed in this article we recommend you seek personal financial advice. Please be aware that, without the benefit of financial advice, you may be committing yourself to financial strategies or products that are not appropriate for your overall personal situation, needs and objectives.

written by:

Ben’s career began in April 2008 specialising in taxation and business advisory by managing a small portfolio at a young age. He joined McKinley Plowman in 2014 as a Senior Accountant and with his passion for business and assisting clients in achieving their objectives he has progressed to a Business Services Manager, and more recently being appointed as an Associate Director.

As a qualified Certified Practising Accountant, his areas of expertise include but are not limited to, assisting clients with new business start-ups, advising on business structures, tax planning, business valuations and management reporting across many industries.

Ben prides himself on being part of his client’s business journey in taking them from where they are now and working towards where they want to be.

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