Negative gearing is the mechanism by which the Australian Tax Office (ATO) provides you as an Australian taxpayer a concession on the costs that you incur related to investment assets which currently includes property owned for investment purposes.
In essence, the ATO allows you to deduct expenses related to your investment asset from the income that the investment asset generates. This results in a net profit or loss on that investment asset — this net gain or loss is then added to or subtracted from the remainder of your taxable income. This mechanism can have clear tax benefits to high income earners if your overall loan portfolio is structured and administered in the correct way.
It’s important to understand the type of expenses associated with investment properties that are allowable deductions. The primary expense is usually interest paid on the loan to buy the property. Other expenses include body corporate fees, cleaning costs, council rates, water charges, insurance, land tax and property agent’s fees. In some instances depending on your specific property, your share of the depreciation expense on the building.
Your accountant or the ATO are best placed to advise you on which deductions are allowable and which are not. Again it’s important to understand that when it comes to the loan expenses related to the property i.e. the interest on the loan, the test that the ATO uses, is a test based on “purpose” — what purpose the debt relates to.
A common mistake is that people often believe they can increase their investment property loan, extract surplus equity to purchase their owner occupied home and still have this regarded as investment debt — based on the purpose test, this is not investment related debt, but rather mixed purpose debt and hence not normally all tax deductible debt.
A key point of negative gearing is that it may leave you with a tax deduction, but that it may well also leave you with a negative cash flow situation with regards to that specific property — if your costs are exceeding your income, you will need to ensure you are in a position to be able to contribute the short fall on an ongoing basis.
Negative gearing is also often referenced in the expression “good debt vs bad debt”. Essentially the phrase refers to tax deductible debt vs non-tax deductible debt. Generally costs related to your owner occupied property are not tax deductible, therefore the sensible strategy if you are in a position where you own your own home and an investment property, would be to pay down your owner occupied i.e. non-deductible debt as quickly as possible and keep your deductible debt balance as high as possible This strategy maximises your tax position, whilst managing the combined cash flow requirements of the two loans.
In conclusion, negative gearing is a feature of the current tax system in Australia that could potentially provide you with tax benefits depending on your specific situation. If you are considering a strategy which involves taking advantage of negative gearing benefits we are able to work with your accountant or tax adviser to get the best outcome for you.
Disclaimer: This article contains general comments and recommendations only. This article has been prepared without taking account of your objectives, financial situation or needs. Before taking any action you should consider the appropriateness of the comments made in the article, having regard to your objectives, financial situation and needs and we recommend you speak to your accountant or financial adviser for specific advice.