Negative gearing your investment property
Property investing and negative gearing is a common tax outcome with residential property investing.
A property is negatively geared when the costs of owning the property exceed the rent you receive. In other words, you make a loss each year.
Why is negative gearing a common tax outcome?
On the surface, a property that makes a loss may not seem like a good idea. So why do people invest in these properties?
Firstly, a property that’s well located has the potential to increase in value over time. Take for example a $1,000,000 property purchased today, that grows at a rate of 7% per year, would be worth $1,967,151.36 in 10 years’ time- almost doubling its value.
It would be very difficult for most people to save that amount of money in a 10-year period!
This is what is referred to as the power of leverage.
Secondly, the annual loss can be offset against other income including salary or wages. For example, let’s say your annual salary is $80,000 and your investment property makes a $20,000 loss for the year. In this case you only pay tax on income of $60,000 — not $80,000.
Investing in quality assets is key in residential property
Capital growth is not guaranteed, and all properties are not created equal.
You may have heard that the secret to success in property investing is location, location, location. Whilst we would generally agree with this, what one person might define as a great location, might not be what others define as a great location.
For example, we have recently heard about property buyers recommending purchases in regional towns. From their perspective, the location has potential for a higher growth rate above the average historical return of 7% per annum.
Whilst it “could” produce a higher return in the very short term, it most cases, (at least from our perspective) it would be difficult to maintain this if the asset was held for the medium to longer term which is where the money is made in residential property. The question you’d need to ask yourself, is it worth the extra risk?
You could also consider a property in a blue-chip location, which we would consider as one that is already established with a proven track record of performance and is often associated with a high rate of owner occupiers and families, great transport links, close to a major shopping centre, parks and popular schools.
As you can see in example above, achieving the historical return of 7% would produce a fantastic result after 10 years.
Ability to turn the tables in your favour
Its also worth giving some thought to what is within your control that could reduce the amount of money the property is costing you and/or improve what is already a great investment.
Here’s a few ways you could potentially increase your rental return and “manufacture” capital growth.
- Annual rental reviews with a view to increasing the amount in line with the market is a simple, yet effective strategy to improve your cash flow.
- Granny flats are a relatively cost-effective way to produce an additional rental.
- Renovations can result in an immediate uplift in the capital value of the asset and could also result in the ability to generate a higher rental return.
Everyone has a different situation. Speak to a qualified and experienced accountant/tax professional to work out the right investment strategy for you. For your finance needs, talk to a Build & Protect Finance Strategist.
