Negative gearing is something we love to talk about when it comes to properties. It is a buzz phrase thrown around at get togethers causing all to nod as if they have uncovered the holy grail. But many don't really understand the concept.
Basically, negative gearing is where you borrow to buy a property, the amount of rent you receive from the property in a year is less than the amount required to pay the loan and all other associated costs like rates, insurance and maintenance. When tax time comes around you can offset any loss on owning the property against other income to reduce your overall tax bill. If you are in a high tax bracket this can be beneficial in dollar terms and lets not forget everybody likes to get one up on the tax man.
Say your income from rent is 15,000 and interest and other expenses for the year total $22,500 the negative gap is $7,500. This is the tax deduction allowed to the owner who could save up to half of this on tax. Sounds great doesn't it!
Many get over excited by the concept of buying a property and getting a tax break at the same time. But is not a sure fire way to making money, in essence it is a loss making investment. The “negative” is that you are losing money each month and having to fund the investment with income from another source before you even claim the tax benefit.
The negative gearing scenario should never be the reason for investing. There are risks associated with any investment and they need to be carefully considered before jumping in. Property prices in Australia have been inflated due to negative gearing strategies but in most states rent has slumped. In Melbourne most properties only yield 3.7% gross rent, you would earn more by putting your money in the bank risk-free.
So there are inherent risks, we only need to look back a few years ago in the US where the slump in property prices was the catalyst for the global recession. Showing the great risk of highly geared property investing.
We all invest hoping that one day the capital growth will outstrip the losses made along the way. But it is not necessarily the case. Invest wisely and with the right advice, never let tax breaks be the reason. Invest to make money.