What negative gearing means for investors

When talking about investing, anything containing the word ‘negative’ tends to be a real turn-off. Yet when it comes to property, negative gearing has inspired plenty of people to become investors. Here’s what you need to know to make negative gearing work for you.

Tax and investment

“Tax should not be the major reason for any investment strategy [but] it certainly is a consideration,†explains Deborah Kent, National President of the Association of Financial Advisers and director of Sydney-based Integra Financial Services.

“A positively geared property will mean that you may not receive much tax relief – you will have to pay tax on the income you are receiving. Paying tax will have the potential to lower the return on your investment; you may find that the income return after tax is less than what you can earning in say a bank account, especially if you are paying land tax as well.â€

Hence, the benefit derived from negative gearing is from having reduced tax liabilities at the end of each financial year. Plus, by holding on to the property for at least the minimum required period, you may be eligible for a 50 per cent discount on Capital Gains Tax (CGT) when selling the property.

Preparation is key

“Do your homework, make sure this is the right investment for you; consider the risks and advantages; ensure you can afford it, [and] make sure the structure of the loan is done correctly so you are not disadvantaged tax wise,†says Kent.

She suggests the following points for anyone considering negatively geared property:

• Be prepared. “Be aware of how gearing into property works. The reality is after your tax deduction, in most cases you will be cash-flow negative, depending on the level of rent you are receiving against the expenses, including interest on the loan.â€
• Know your loan. “You need to be aware of the structure of the loan. It is important to gain the most advantage from the highest income earner in the family, rather than say a joint loan where one party is not working and therefore cannot gain any advantage from tax deductions.â€
• Check your growth. “To ensure you are gaining from property investment, you need capital growth, preferably above inflation. Remember, like any asset, property growth will fluctuate and you need to be prepared for this.â€
• Unexpected costs. “There is also the risk of the tenant causing damage to the property, which can be an emotional strain on top of a costly one.â€
• Keep it manageable. “Ensure you can afford this type of investment. Make sure you have adequate income protection insurance in place and seek professional advice from a financial adviser and accountant before proceeding to ensure your structure for tax is the correct one for you.

“Any investment strategy should match your tolerance for risk and you should understand how your funds are invested and be comfortable that you are getting the right outcomes,†concludes Kent. Before taking the plunge, get professional advice on your options to avoid getting sunk by debt.