Negative gearing is an investment strategy in which the costs of owning and maintaining a rental property, such as home loan interest and maintenance expenses, exceed the rental income the property generates. This results in a financial loss, which you can deduct from your taxable income to lower your taxes.
The goal of investing is to make a profit. So if you are making a loss on your investment property each year, then why keep it? Property growth is typically very strong in Australia. Investors who hold a property despite it being negatively geared are expecting to make back the money lost, and then some, when they finally sell. The ability to deduct losses from your taxable income makes it easier to hold the property, and even though you do pay capital gains tax on the profits when you eventually sell, windfalls are still common.
Negative gearing has been a focal point in Australian property investment for decades. Introduced in the early 1930s to encourage investment in the housing market, it has since become integral to property investment strategies. In 2020-21, negative gearing cost the Australian Federal Treasury about $2.7 billion. Total tax concessions for rental properties are expected to rise to over $28 billion by 2026-27.
How Does Negative Gearing Work?
To calculate negative gearing, follow these steps.
1. Calculate Rental Income: Determine the total rental income the property generates over the financial year. This includes all rent payments received from tenants.
2. Add Up Expenses: Calculate all expenses associated with owning and maintaining the property. Common expenses include home loan repayments including interest, property management fees, maintenance costs, insurance and council rates.
3. Determine Net Income or Loss: Subtract the total expenses from the rental income. If the expenses exceed the income, the result is a negative figure, indicating a loss.
Example: Let’s suppose your rental income is $25,000 and expenses total $35,000,
$25,000 – $35,000 = -$10,000.
This $10,000 is your net loss.
4. Deduct from Taxable Income: Deduct the net loss from your total taxable income, such as your salary or business income. This leads to a lower tax bill.
Example: If you earn $100,000 on your job and have a $10,000 loss from your property, your taxable income reduces to $90,000. This means you pay tax on $90,000 instead of $100,000, resulting in tax savings. Assuming a marginal tax rate of 30%, the $10,000 loss reduces your tax liability by $3,000.
Changes to Negative Gearing in 2024
As of July 2024, there have been no direct changes to negative gearing in Australia; however, the issue is a hot topic, as there are calls for reform.
Here’s what’s happening:
- Calls for Reform: Senators Jacqui Lambie and David Pocock have been pushing the government to address housing affordability by reforming negative gearing and the capital gains tax discount.
- Potential Impact: The Parliamentary Budget Office even modelled the impact of various reform options, suggesting potential benefits for housing affordability and government finances.
- Government Position: The current Labor government, led by Treasurer Jim Chalmers, has so far ruled out changes to negative gearing.
So, while there are no immediate changes, the debate on negative gearing reform is ongoing in Australia.
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Is Negative Gearing Worth It?
Negative gearing is worth it if you have the financial stability to handle annual losses and are looking to benefit from long-term capital gains. However, it comes with risks such as potential changes in market conditions and regulations that can affect your investment returns.
Here are the pros and cons of negative gearing.
| Pros Of Negative Gearing | Cons Of Negative Gearing |
|---|---|
| Tax Savings: Reduces taxable income, leading to lower annual tax payments.Tax Savings: Reduces taxable income, leading to lower annual tax payments.Reduces taxable income, leading to lower annual tax payments. | Ongoing Financial Losses: Requires accepting annual financial losses, which can strain cashflow. |
| Capital Growth Potential: Investors expect property values to rise over time, leading to substantial long-term profits despite short-term losses. | Dependence On Market Appreciation: Relies heavily on property value increase. If values stagnate or decline, expected gains may not materialise. |
| Entry Into Property Market: Negative gearing can make it possible to buy property in desirable areas by leveraging tax benefits to offset costs. | Interest Rate Risk: Rising interest can increase repayments, increasing the gap between investment income and costs. |
| Portfolio Diversification: Makes it easier to add real estate to investment portfolio, spreading risk. | Market Volatility: Property market fluctuations can hurt returns and increase short-term losses. |
| Rental Income Growth: Rental income may increase over time, potentially turning losses into profits. | Regulatory Uncertainty: Possible changes in tax laws or policies could reduce the benefits of negative gearing. |
Evaluate your financial goals and risk tolerance to determine if negative gearing aligns with your investment strategy.
How Does Negative Gearing Affect Tax Returns?
Negative gearing allows you to deduct the financial losses incurred by your investment properties from your other taxable income. This results in a reduced tax liability and lower tax payments.
For example, if you incur a $10,000 loss from a negatively geared property and your marginal tax rate is 30%, this reduces your tax liability by $3,000.
Positive Gearing Vs Negative Gearing
Here is a table comparing positive gearing and negative gearing:
| Aspect | Positive Gearing | Negative Gearing |
|---|---|---|
| Definition | When rental income exceeds property expenses | When property expenses exceed rental income. |
| Tax Impact | Increases taxable income as profit is generated. | Reduces taxable income by offsetting losses against other income. |
| Cashflow | Provides positive cashflow, as rental income covers expenses and more. | Results in negative cashflow, as expenses are higher than rental income. |
| Investment Strategy | Suitable for investors seeking immediate income. | Suitable for investors aiming for long-term capital gains. |
| Risk Level | Lower risk, due to consistent positive cashflow. | Higher risk, as it relies on property appreciation and potential future profits. |
| Capital Growth Dependency | Less dependent on property value appreciation. | Highly dependent on property value appreciation over time. |
| Tax Benefits | Profits are taxable, but some expenses are tax-deductible, including depreciation, interest on your loan, and the expenses of owning an investment property (e.g., property management fees and council rates). | Tax benefits from deducting losses against other income. |
| Market Conditions | Preferable in stable or declining markets where rents are stable or rising slowly. | Preferable in growing markets where property values are expected to rise significantly. |
| Investor Profile | Ideal for risk-averse investors seeking steady income. | Ideal for investors with high income or those willing to accept short-term losses for long-term gains. |
How Does Negative Gearing Affect Housing Affordability
Increased investment in the Australian property market, driven by negative gearing, has been linked to rising house prices. This makes homes less affordable for first-time buyers and low-income earners. Studies suggest negative gearing is a great factor influencing investment decisions and property speculation in Australia.
The impact on rents within the Australian context is more complex. Some argue it increases rental supply, thereby keeping rents down. Others contend that abolishing negative gearing could lead to rent increases, similar to the situation in Perth and Sydney in the 1980s following its brief removal in Australia.
To address housing affordability in Australia, some experts advocate for reforming negative gearing, rather than complete abolition. Potential reforms include:
- Limiting the number or type of properties eligible for negative gearing deductions.
- Increasing capital gains tax on investment properties.
- Allowing first-home buyers in Australia to claim tax deductions for mortgage interest.
- Increasing government investment in public and affordable housing initiatives.
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