Negative gearing -Short simple example

| June 19, 2012

Negative gearing in action

Jenny uses her $50,000 deposit to borrow $350,000 and buy a $400,000 investment property. At 8% the annual repayments total $28,000 on an interest only loan. The rent she receives from this property is $400 per week, or $20,800 per year – leaving her out of pocket by $7,200 per year.

Other expenses include rates, levies and maintenance costs, which add up to $3,500 per annum. Jenny has now spent $10,700 to own that asset over and above the income she has received for it.

negaitve gearing australia property  investment

So when it comes time for Jenny to do her taxes she will be able to reduce her taxable income by $10,700. That’s negative gearing.

But wait there’s more! _  ( Negative gearing )

Jenny’s property was built in 1995 and Washington Brown Quantity Surveyors has advised Jenny that she can claim $8,000 in the first year for depreciation.

So now Jenny can tell the ATO to reduce her taxable income by $10,700 plus the $8,000 in depreciation allowance (a total of $18,700).

The reason we have separated the depreciation from other out-of-pocket expenses is because Depreciation Allowances are not reliant on whether the property is negatively geared, positively geared or cash flow neutral.

Most investors are willing to accept a loss in income if they believe they will be compensated by capital growth in the future. But you must be able to fund this shortfall while you wait for the investment to appreciate in value.

You also need a taxable income from which this loss can be negatively geared against. And the higher your income, the higher the benefit will be.

For instance, if Jenny were on the highest tax rate of 45 percent, her $18,700 loss has now resulted in an $8,415 tax refund ($18,700 x 0.45% = $8,415). So in real terms it has only cost Jenny $2,285 ($10,700 – $8415 = $2,285) to maintain this investment in that particular year.

So for approximately $44 per week, Jenny owns an asset that will hopefully increase in value. If her property appreciates 5% in the first year, that’s an increase of $20,000 with a $2,285 holding cost.

Sounds good doesn’t it!

But the reverse applies – if Jenny’s property goes down 5% then she’s lost $20,000 off the market value of that investment.

At the end of the day, there is no point negative gearing into an asset class that decreases in value.

But history has shown that if you buy well-located property at the right price and hold it long term, it has been a great investment.

And if you can do that whilst keeping the holding costs to a minimum – then your gains are magnified


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Category: Banks, Featured, finance, investment property, negative gearing, positive gearing

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Comments (4)

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  1. At first, i thought jenny was out of her mind but with the tax exemptions due to depreciation, I think her case is forgivable.

  2. Taren says:

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    wanted to give a quick shout out and say I genuinely enjoy
    reading through your blog posts. Can you
    recommend any other blogs/websites/forums that go over the same
    Thanks a lot!

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