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Negative gearing is about as controversial of a topic as you can get in investing here in Australia.
It’s always in the media and generates a lot of attention. So what is it, when should you do it and is it still relevant today? Watch the video to find out!
Transcript:
Today’s video we are going to be talking about one of the most controversial topics in investing here in Australia and that is on negative gearing, and whether it is still relevant in today’s environment.
What is it?
Many of us will remember Labor losing the unlosable election last year, with one of its key policies the abolishment of negative gearing. But what is negative gearing and why the fuss about it?
Well, negative gearing is when expenses associated with an income producing asset like an investment property or shares, are greater than the income it produces. We hear it everyday in the media, usually in relation to negative gearing in our property markets.
Here’s how it works by way of an example, if I earn $10,000 p.a. from rent on an investment property, but it costs $15,000 to hold this property in the form of interest repayments and other expenses, than I am negatively geared by $5,000.
I am then able to claim this $5,000 difference as a tax deduction against my other income such as salary or wages.
Oh and positive gearing is the opposite, when you make $15,000 and incur $10,000 in expenses, you receive $5,000 as income and hence pay tax on this.
Why do negative gearing then?
You may be thinking, hang on, $10,000 in and $15,000 out?
Why would anyone want to do this? Well, negative gearing works if the money an investor makes from the property’s capital growth is greater than the loss they make from the rental shortfall. So, in our example, if the capital growth or the value from holding the property is greater than $5,000 p.a. then I come out ahead.
It is controversial because it is partly the cause of the significant rise in property prices in our capital cities over the last two decades.
It’s also quite popular, with an estimated 1.3 million investors owning a negatively geared property.
When should you do it?
Negative gearing can be a good idea if:
- You have enough disposable income to hold the property – because remember you are covering losses from the property itself
- When you want to save tax – because it is a tax deduction, many high income earners do negative gear
- An increase in the property or rental value is expected – like I mentioned before, negative gearing works if the growth from holding the property exceeds the amount negatively geared.
When should you NOT do it?
- If there are no increases in property or rental values – then you are just making losses from a dud investment
- When your disposable income is low – cash is king, and if cash-flow is tight, you don’t want to be spending more than you can afford.
- When you want to expand your portfolio and build passive income – generally you’ll run out of money if you keep on buying negatively geared properties as each requires you to tip more money in than you get out.
Should I do it?
Well, everyone’s situation is unique, but my personal opinion is that negative gearing is just a tax strategy for a point in time.
At the end of the day, it comes down to the asset itself and how it fits into your investment goals.
Because what is a negatively geared property today can very well be a positively geared property in the future. Similarly, if property prices don’t rise in value, then you are just throwing away good money after bad.
But like everything in investing – it comes down to the numbers and your risk profile. So make sure you work out the ongoing out-of-pocket expenses, any potential increases in interest rates and other fees, before jumping in.
Hopefully this video has given you some food for thought on negative gearing and whether it may or may not work for you – let me know if the comments below what you think!
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