When talk turns to real estate the term "negative gearing" is one guaranteed to pop up. But what does it mean and is it still a wise investment strategy? Bronwyn McNulty reports.
First, the definition: if you negatively gear a property you own, it means that your expenses are greater than your income. All of which sounds like a dud deal, until you consider that those losses can be offset against any other income to provide a tax deduction.
And while those losses continue to accumulate, and the tax deduction continues, meanwhile the property itself is growing in value anyway given growing market conditions. Note the proviso there, "growing market conditions" on which there will be more to say later.
Adrian Raftery, also known as Mr Taxman, says people who negatively gear their properties are often relying on capital growth to offset their losses down the track.
“Let’s say your expenses are $5000 more than the rent,” Raftery says. “When you do your tax return, you have a $5000 loss. Your refund will be whatever your marginal tax rate is. If it’s 46.5 per cent, you will get $2325 back.
“You are still out of pocket. The only way you are going to be in front is if your property increases by that amount in value. For example, if your net outlay was $2325 and your capital value increased by $30,000, then you have had a huge win.”
Bear in mind that any gain on the property will be subject to capital gains tax when you sell.
“Net proceeds will be added to your taxable income and taxed at your marginal tax rate,” Raftery says.
If you hold the property for more than 12 months, only 50 per cent of your net gain is taxable.
When interest rates are high and property prices on the rise, negative gearing seems like a sure-fire way to get a foothold in the property market while making a quick buck.
But what about times like now, when the market’s flat, interest rates are low, and rents are high?
“First of all, if you can positively gear your property, fantastic,” Raftery says. “But now is a good time to negatively gear if you choose wisely.
“Growth happens in spurts, in two or three-year lots. So you are better off buying a property now rather than in three years time when prices have peaked again.”
If you heed the advice of Kevin Lee, general manager of Smart Property Adviser, property prices are not going up any time soon.
“Negative gearing can go so wrong because people see capital growth as a given,” he says. “My suggestion is that that’s all about to change.
“The property market is changing. There will be 5.6 million baby boomers exiting the system between now and 2020, and for the last 40 years they were the biggest income earners, the wealth creators and the investors in real estate. They caused the wave of capital growth.
“I describe negative gearing as supporting your tenant’s lifestyle, and that’s what I advise people not to do. I am teaching people to go back to the generation before [the baby boomers] and have the tenant pay the loan off for them.”
Saul Eslake, chief economist at the Bank of America Meryl Lynch Australia, agrees with Lee.
“Ten years ago [negative gearing] was a highly effective strategy,” he says. “But 10 years ago interest rates were higher and property prices were a long way from reaching their peak.
“I wouldn’t advise anyone I cared about to adopt negative gearing now without giving it very considerable thought and research.”
Have you ever negatively geared a property? Did it work for you?
Important Information: As this information has been prepared without considering your objectives, financial situation or needs, you should, before acting on this information, consider its appropriateness to your circumstances. The information on taxation is of a general nature only and is based on the continuation of present taxation laws, rulings and their interpretation. As individual circumstances differ, you should seek assistance from your taxation adviser. Commonwealth Bank of Australia ABN 48 123 123 124.