Briefly what is Negative Gearing…
Gearing basically means borrowing to invest in something. It can apply to just about anything from property to shares. These investments can be positively, neutrally or negatively geared.
When people refer to negative gearing, they are usually referring to the cost of holding an investment (usually a property) outweighing the income return generated from it.They have bought something which does not return enough funds to them to cover the ongoing expenses involved in holding it (eg interest, maintenance, agency fees etc). This loss is listed in their tax return and offset against the tax they pay, so they receive some funds back from the government.
Property is usually the preference for negative gearing for Australians for perhaps three main reasons:
1. A house is a physical thing. You can go there, see the property, walk around it and open the front door. It gives investors comfort.
2. Banks will typically lend more with less deposits for real estate than any other asset. And there are no margin calls like there are with shares when prices move.
3. And depreciation on the property provides additional tax deductions.
Why do people do it?
Borrowing to invest can magnify both your returns or your losses. Plus people love getting money back from the government through paying less tax.
It is a bit of a gamble on house prices increasing, as negative gearing only really pays off when you sell the property/shares. In the short term people are actually out of pocket, however in the long term it can deliver excellent capital growth.
How can it affect you? (The important bit)
If you are working..
- 1. Remember you are taking on additional debt. It has to be something that you are comfortable with for the next 10-20years+.
- 2. Keep in mind that you are not likely to see a return for a long time. Property investment is a long term plan. Property usually only increases in value over time.
- 3. Remember tax-back is only paid once a year. Do you have enough funds to cover all extra costs like having no tenants for 2 months?
- 4. And most importantly borrowing to invest can magnify both your returns and your losses!
- If you aren’t working and paying tax you will be eating into your only income.
Keep in mind…
- Interest rates change. Currently they are low but they have been as high as 9% in recent times. Do you have enough of a financial cushion to cover spikes in interest rates?
- Houses take time to sell. If you suddenly need $10,000 you can’t just sell the front porch!
- Remember to get a tax reduction you have to spend money on a monthly basis
- The aim is capital growth. There is no point buying property that isn’t likely to rise in value. This is key. Too many people get sucked in on supposed tax benefits and get stuck owning a dud.