Financial Planning Lesson – # 1 – Negative Gearing

Welcome to our series of financial planning lessons that we’ll be running over the next few months.  The lessons will assist those clients looking at getting into property as an investment or home, and we’ll start with the basics and build up to some of the more complicated lessons.  Todays lesson is on negative gearing.

We have a large amount of clients that are in the Defence Force and a couple of the topics will be specific to them in the later lessons.  We’ll inform you once we are conducting those lessons.

Lets start by quickly going over the myth around negative gearing.  It’s definitely a bonus when you receive a tax deduction for the loss of money you’ve made on an investment but if the asset is not growing at a rate larger than the cash loss, then you’re losing money.  It would be much better to have a positively geared property if clients are able to.  This can be achieved by rental yield and a larger deposit.

Lets go over what negative gearing is.  Lets assume you have a $500,000 debt against an investment, interest rate is 6.7% and there are $5,000 p.a. of costs for rates etc.  So the total outgoing for this investment is $38,500.  Lets assume that you rent the investment property for $500/wk which is $26,000p.a.  So you’re making a cash loss on the property of $12,500p.a.

So if your annual income is $80,000p.a. then you’d pay $18,747 in tax on this.  Due to the negative gearing on your property your annual income is no longer $80,000 as you’ve made a $12,500 loss, so it’s actually $67,500 that you need to declare to your accountant.  Now the tax payable on this amount is $14,497.  So you’ve paid too much tax for the FY and the ATO will give you a tax refund of $4,250 which is the difference.

So you’re still making a cash loss of $8,250, so we need the investment property to be growing at a rate that’s faster than this.  If not we are losing money.  So although Negative Gearing is good and helpful you just need to be cautious in the way you use it.

Please contact us if you have any specific questions about negative gearing or would like further information on the topic.  We are happy to conduct an assessment of your financial position as well.

Financial Planning Lesson – # 2 will be on tax variation forms.  Stay tuned for this next week.