Buying An Investment Property
What is Negative Gearing?
Negative Gearing by definition is where you borrow to acquire an investment
and the interest and other tax deductible costs you incur exceed the income
you receive from the investment.
While Negative Gearing is commonly associated with rental properties,
it can also be applied to other types of income-producing investments
such as shares and managed funds using what is often called 'margin loans'.
In terms of property investment, negative gearing refers to a situation
where your expenses to maintain the property (including mortgage interest)
exceed the rental income.
Creating wealth through purchasing an investment property is a well established
practice in this country. The attraction of borrowing or gearing to invest
is that it enables you to invest in shares or property that might otherwise
have been unaffordable. For individuals, the loss can also be offset against
other assessable income and the tax benefit will depend on your marginal
Make no mistake, it can be a risky business because while gearing
can amplify your gains, it can also magnify your losses. There is no better
example than the 2008 US sub-prime lending crisis where the collapse of
the US Property Market left some 30% of mortgagees with a loan balance
higher than the value of their property.
If you negatively gear property, you need to understand
some important points:
Properties are expected to generate profits only through
capital gains and the gains need to be greater than the total losses incurred
over the course of the holding period.
Of course, there is no guarantee that the value of the property
will appreciate, or at least appreciate enough to cover your losses.
Investing in property requires planning and extra caution must be exercised
when a property is projected to generate a negative cash flow. Tax benefits
should not be the only reason for the property purchase.
For taxation purposes, depreciation on the building could
be tax deductible, however, the depreciation also reduces the 'cost base'
of the property. The greater the depreciation you apply on your property,
the lower the cost base value which may result in a larger taxable capital
gain on sale.
Negative Gearing isn't suitable for all investors. Although
it can lower your tax liability, the tax implications will depend on your
personal situation and the type of investment you choose. Negative Gearing
implies a negative cashflow that you need to fund from other sources.
You have to remember that the family home is a purchase
from the heart while an investment property needs to be a purchase from
the head. You've heard the old saying that the three most important things
when buying a property are: 'location, location, location' and this is
even more important when buying an investment property.