In the space of a year, there have been 10 official consecutive interest rate rises – plenty of positively or neutrally geared investment properties have slipped into negative territory. After a significant 3.85% jump in the cash rate, savvy investors are now rethinking their medium to long-term strategies.
While some property investors actively choose a negative gearing path, others have only recently found themselves navigating the oft-talked-about mortgage method due to the fast-paced interest-rate climate. There are tax-related perks that come with negative gearing, but the strategy doesn’t necessarily make sense for everyone. To work out if negative gearing is right for you, it might be time to give your property investment plan a ‘health check’.
Advantages of negative gearing
Disadvantages of negative gearing
What is positive gearing?
Neutral gearing explained
How it works on both sides of the “gearing” fence
Taking the positive approach
Let’s take a look at Anna’s story. She’s worked hard to save a $170,000 deposit to buy an investment property and after finding the right place, put that cash down as a healthy 40% deposit towards the $425,000 cost.
Now tenanted, the property makes $2,000 in rent a month and the mortgage along with other expenses adds up to $1,000 a month. That’s $1,000 of positive monthly income, or $12,000 a year. This $12,000 income will be included as part of your total taxable income come tax time.
Negative gearing in action
Henry owns an apartment that is generating $20,000 a year in rent. Because he started with a 15% deposit, he is highly geared with a large mortgage interest bill of $25,000 a year. Then there’s $4,000 in annual expenses, so overall his investment property is costing him $9,000 a year.
This loss can now go towards reducing his taxable income, and ultimately his tax bill at the end of the financial year.
Since he is taxed at 33%, offsetting the $9,000 against his taxable income drops the final ATO bill by $3,000. Now Henry’s out-of-pocket costs are only $6,000 which he feels comfortable taking on in the expectation he’ll make significant long-term capital growth.
What to consider when negative gearing
- Can I realistically pay for the property while also losing money on it?
- If interest rates continue to rise, can I still afford this strategy?
- Is there scope to increase the rent to meet the mortgage demands?
- Is the property going to appeal to a high number of potential renters so it never sits empty?
- What happens if I can’t find a quality tenant or even one at all?
- Has the home got good capital growth potential?
- When, if ever, will the property be positively geared?
Will the potential tax benefit, coupled with the profit I hope to make upon its sale, outweigh the negative gearing losses?
Is negative gearing still worth it?
As the cost of living and the price of holding a mortgage continues to increase, negative gearing will eat more and more into your monthly expenses. While it can be a highly effective strategy to reduce your tax bill and unlock capital gains, there are a lot of other things to consider.
If your household budget is already tight in the current climate, then perhaps this isn’t a path for you. However, if you have crunched the numbers and are confident you can absorb the extra costs then negative gearing might just be the right fit.