Negative gearing essentially turns your property into a business, if it costs you money to hang onto that property throughout the course of the financial year, then that loss can become a deduction off your income.
I have provided the following as a rough example;
$400,000 investment villa, purchased in 2012, built in 2010, renting at $440 per week, $3,000 per year for rates and taxes, 1,200 per year for insurance, $420,000 loan with an interest rate at 5.29% 3 year fixed.
We will divide our expenses into two areas, physical costs such as interest, rates, repairs and insurance and virtual or non out of pocket expenses such as depreciation.
The property generates $22,800 in rent a year, the client receives around 90% of this after management fees have been deducted, leaving roughly $20,592.
The interest on the property is $22,218 per year, along with rates and insurances of $4,200 per year this takes the costs to $26,418 per annum in physical costs.
The result of the above is a loss for the year of $5,826, any loss will mean the property is negatively geared.
If we say the owner is making $70,000 per annum in income, they are currently paying around $14,297 in tax giving them a net income of $55,703. If we apply the above loss of $5,826 to the clients income, this takes them down to a taxable income of $64,174, reducing their tax paid to $12,404, resulting in having to pay $1,893 less in tax, reducing their out of pocket expenses on the investment property to $3,933 per year.
The loss of $3,933 per year represents just under 1% of the property’s value per year, so as long as the investment property grows at greater than 1% per year they are in front.
Now if we throw depreciation into the mix, we can further improve on the above figures. As the building was built after 1985, we can claim 2.5% of the building cost as depreciation until the building reaches 40 years of age. If the building cost $130,000 to build, you could claim $3,250 per year as depreciation on the building. Depreciation is a good loss in the sense that it has no physical cost attached to it.
So applying depreciation to the loss will take the $70,000 income down further to $60,924, resulting now in only $11,347 paid in tax, taking the out of pocket expenses down to just $2,876 for the year, equaling just .72% of the property’s value.
So applying the figures and gearing above we have taken a loss of $5,826 per year or $112.04 per week, to $2,876 per year or $55.31 per week. Halving the holding costs and giving every chance to the property to be a better investment.
It should be noted the above is a simple example, you cannot factor in the issues you can potentially experience as a landlord and you should always consult with your accountant prior to any investment purchase or speculation.
The opinions above are those of the author and do not constitute financial advice. Any decision on your financial future should be carefully considered, advice sought and relevant research carried out.