Effects of negative gearing to rental property

Effects of negative gearing to rental property

Buying a property to live in is the aim for many individuals and families across Australia. After all, having a couple of kids and securing a home with a white picket fence is the dream, right? Well, be that as it may, there are times when the pursuit of property, and all of the applicable research into finances, mortgage rates etc, is best put toward an investment.

Catching the market at the right time can be tough, but there are certainly occasions when it just makes financial sense to try and get a foot on the property ladder, with the view of making a profit over the long term.

Naturally, one of the best ways to do this is to combine any capital gains that a property presents with an ancillary source of income. In most cases, this will be in the form of rent payments. There are a few ways to go about this effectively, with all of them centred on the appropriate level of 'gearing'.

What is gearing?

Research collated by Bank of New Zealand (BNZ) explained that there are two simple forms of gearing: Negative and positive. In essence the latter secures some form of external income to support your initial outlay on the home loan, while the former is more about making a return from the aforementioned capital gains.

There are benefits to both, but positive gearing can be more dependent on finding precisely the right kind of 'cashflow property', while any home being bought as an investment can be negatively geared within reason.

So, to look a little more in-depth at negative gearing when it comes to rental properties, there are a number of things to consider. It may seem a little odd to effectively make a loss when it comes to total outgoings and interest on mortgage payments.

However, as BNZ noted, many rental property owners are happy to do this. The reason is that their expectation that the property will increase in value outweighs the pains of having more finances outgoing than incoming to begin with.

Gearing in finance can be related to the gears found on a bicycle - it helps turn a small effort into bigger gains.

The tax implications of negative gearing

Like any kind of investment, positive returns need to be reported to the Australian Tax Office (ATO) accordingly. Generally, any costs incurred in earning income tend be tax-deductible, according to Taxpayers Australia.

Consequently, when a loan is needed to buy an income-producing asset, in this case an investment property, the interest on that loan is also tax-deductible. This is one of the key advantages in pursuing a negatively geared property.

From the tax perspective, it's a win-win situation, as you can avoid being penalised on any costs it may take to keep the property afloat while also not feeling the effects of taxation on the interest against any mortgage payments.

Taxpayers Australia also pointed out that there are some allowable expenses that are tax-deductible specifically on investment properties. For example, general wear and tear that occurs by having tenants in and around the home may be costly to repair, but any such work can be claimed against accordingly.

Naturally, there are a whole host of nuances to tax law in Australia. While the basics of what can and can't be deducted as part of a rental property investment are relatively straightforward, it may be best to consult with a savvy accountant to establish the precise amount of money you could save thanks to negative gearing.

There are a whole plethora of tax breaks that a negatively geared investment can offer.

Can capital gains still have a big impact?

As noted, the potential for capital gains over the course of several years - or even decades - is one factor that can make a negatively geared investment property an inspired choice. However, is playing the long game in this way as fruitful as it has been in the past?

Founder of Smart Property Adviser Kevin Lee believes that investors need to be particularly careful in today's market if they hope to achieve similar results as their peers may have done 30 years ago, when negatively geared investments first rose to prominence.

"If you are investing for income, and the income is paying for the property, then you are a savvy investor. But there are no guarantees for capital growth," he explained to the Australian Financial Review.

That's not to say than any would-be property investor should be put off negative gearing altogether, just that it has to be dealt with carefully.

 The wider rental market can be dictated by negative gearing, as was seen over 30 years ago when the investment strategy was briefly abolished.

Negative gearing and the rental market

Negative gearing as it is today is actually a healthy thing for the wider property market. This is due to the fact that investors have to charge reasonable rates of rent in line with any tax deductions.

In fact, back in 1980, negative gearing was removed across Australia for a short amount of time. The net result was a surge in prices for tenants as investors looked to make up for funds that were being lost elsewhere, according to a report from ABC News.

Ultimately, negatively geared investment properties offer benefits to savvy buyers who have secured the applicable finance and done their homework on mortgage rates, and they can even be a positive for those in the rental market, as well.

Consequently, negative gearing as a form of investment looks set to be around for some time to come. If you're considering investing in a home or apartment in the not too distant future, exploring ways to make that endeavour as profitable as possible should be a top priority.

While there are never any guarantees when it comes to seeking profit over a long period, the mixture of taxation benefits and ideally capital gains will certainly be appealing.

As touched on, it's important to consult with the experts if you're unsure about the process, but a negatively geared investment property could prove to be a profitable choice if you have all of the applicable home mortgage information, deposit and other finances all set and ready to go.

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This information has been prepared without taking into account your individual objectives, financial situation or needs. You should, before acting on this information, consider its appropriateness to your circumstances.

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