Here’s what you need to know about negative gearing and managing your rental property in Australia.
Interested to know about managing your rental property? Steve Douglas from SMATS Group explains more.
Since the 2019 Federal Election, there has been much confusion about negative gearing in Australia when the Labour Party ran a policy to abolish it. After losing the election, and largely due to public backlash against its removal, there have been no changes to the current law around it.
What is negative gearing?
Negative gearing is the sensible investment practice of having interest costs of borrowing higher than the net annual income of the asset, which is typically property. In Australia, if interest and expenses are more than rent, the balance is claimable as a tax deduction. Ideally, the asset will eventually produce enough money to cover the costs. The reason people employ negative gearing is because the short-term losses can be beneficial to the owner’s tax bill in certain instances.
It is important to note that negative gearing should only be undertaken when there is a genuine belief that asset value growth will be more than the annual shortfall. Meaning? The overall investment is still profitable. The tax benefits of negative gearing are a consequence of good investment decisions and should not be the main driver.
What about rental property?
Traditionally, borrowing interest rates have been much more than rental in Australia. It was therefore easy to generate an annual tax loss and claim it as a deduction. Rental property in Australia can expect to earn approximately 2.5 percent per annum of net rental (after holding costs).
And how does negative gearing work on property rental? If someone borrows a loan on 80 percent of the property value at interest rates of 5 percent, that is an equivalent of 4 percent of the property value. After taking off the 2 percent net rental, an annual tax cost after interest of approximately 1.5 percent would result. If your property was worth AUD $500,000, this would mean a holding cost of $7,500 (1.5 percent after tax cost) and this is the negative gearing tax claim you would be entitled to at prevailing personal tax rates of 32.5 percent to 45 percent (excluding Medicare Levy), hence a tax refund or savings of many thousands of dollars.
With interest rates now closer to 3 percent, the same 80 percent loan would have a cost of 2.4 percent against the net rental of 2.5 percent – so indeed the property is no longer negatively geared, but positively geared (more income than expenses and interest). As such, buyers would not be generating a tax deduction but now potentially paying tax on the positive net rental.
Which is better?
Being positively or negatively geared is not a bad thing either way. The important thing: With the property you buy, have faith in its ability to generate consistent rental, cover as much interest as possible and its real potential in increasing value for the future.
“Australia continues to prove itself as a reliable and safe property market, providing continued confidence to invest.”
Steve Douglas is the Co-Founder and Managing Director of Australasian Taxation Services (ATS). ATS provides specialist taxation services for anyone looking to invest in Australian property, including Australian expatriates living overseas. Areas of specialisation include the Australian taxation aspects of property investment, as well as expatriate and migration planning.
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