When it comes to property investments, it’s important to have a strategy behind your investment. People often ask should I use negative or positive gearing when buying investment property? The answer will depend on how much you are currently earning and whether you are more interested in capital growth or income from your investment. Read on to find out more about these strategies and how to decide which one is for you.
Negative Gearing
We often hear the term negative gearing when it comes to an investment property. In a simple term, negative gearing is where rental income generated from an investment property is less than mortgage interest and other holding costs, such as rates and maintenance. It generates negative cash flow and you need to put in some of your surplus cash to support the ongoing costs of the investment. However, the negative cash flow is compensated by tax savings due to rental loss being able to offset against other income, such as salary and business income. The tax savings can be further increased due to those non-cash flow items, such as amortisation of borrowing costs and depreciation on plant & equipment and fixtures & fittings.
Negative gearing deductions are most beneficial to those individuals in the high-income tax bracket with a top marginal rate. The larger the borrowing, the more interest deductions that they can use to offset their salary. For someone who is taxed at a top marginal tax rate, if they have $100,000 in rental loss, that is equivalent to $47,000 in tax savings.
Although tax savings offset some of negative cash flow, the property can possibly be in a negative cash flow mode for many years when it may eventually become cash flow positive due to the principle loan being paid down over the years. For those reasons, negative gearing strategy suits better for those younger ages and years before they reach their retirement stages.
No one would want continuing negative cash flow for the sake of tax benefits as the benefits are unlikely to offset the out-of-pocket amounts. The ultimate goal for negative gearing is to achieve a decent capital growth, which can eventually offset the accumulated negative cash flows and in the meantime, make some gains on the disposal of property.
Positive Gearing
Conversely, positive gearing is where the rental income generated from an investment property is greater than the expenditures. Instead of putting in money, you can get constant cash inflow from a rental property. However, you will also need to pay tax on the positive rental income when you lodge the tax return.
Positive gearing property may not suit those individuals already in the marginal tax rate but may suit those with poor cash flow and in the later stage of their life, who seek constant cash inflows to support their living expenses. Those positive geared properties are often hold in a family trust, which can distribute the net income to its beneficiaries. On the other hand, if the property is negative geared, the rental loss will be trapped in the trust. Positive geared properties are also popular in a Self-Managed Super Fund, which can generate the positive income to support the retirement needs and gain a concessional tax rate at 15% on rental income.
If a property can achieve positive income at its early stage of investment, it could potentially mean that the property is not in demand and investors see little capital growth in the long term. In a less competitive market, the price of the property is relative lower which results in a smaller amount of mortgage. It may also imply that the tenants would rather pay rents than buy a property if the costs are similar with little hope of growth in value in the long run.
We recommend you to seek professional advice when purchasing an investment property. We are happy to recommend property strategist Rene Marzinger from Mirren Property Investment on (02) 8814 5275. For some great property investment ideas, please check their blogs at https://www.mirren.com.au/blog/
If you need some assistance in understanding the taxation impacts on negative or positive gearing, please contact Beyond Taxation today on 1300 552 993 or email Joy@beyondtaxation.com.au