New investors often ask what negative gearing actually is. To those new to real estate investment, the term can be confusing and there are a lot of misinformed opinions on the subject. In reality it’s quite a simple concept.
Negative gearing can be described as an investor borrowing money to invest (this is what is described as gearing), whilst the income generated by the investment is less than the interest and related outlays to own and manage the investment, resulting in a loss (this described as negative). So the concept is two words matching two factors that make the negative gearing process. In addition to this the loss is tax deductible, which will reduce the overall amount of tax the investor pays.
Here is an example:
You borrow $400,000 to buy a property.
You receive $20,000 in rent for the year,
You pay out $24,000 in interest, and $3,000 in other costs like land rates and insurance.
The net loss is $7,000, ($20,000 income less $27,000 expenses), which will reduce your taxable income, so the real after tax cost is only $3,745 assuming a tax rate of 46.5%
It’s should be noted that investing just for the tax break can bear its own risks. Negative gearing will still cost you money, even after the tax deduction, so the investment must make a capital gain over time that is more than what it has cost you to hold it.
The longer you keep the investment the more likely this is to occur, so negative gearing should never be considered a short term strategy. It is recommended to plan for a time frame of at least 10 years before negative gearing is considered as a sound investment strategy.
Contact Alert Property group for more information.