Negative gearing

An easy way to profit from residential property or a fashionable way to lose money?
 
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  • Updated:7 Jan 2006
 

02.How it works

Using simple numbers, let’s say John, who earns $90,000 per year:

  • Borrows $450,000 to buy an investment property.
  • Pays interest at 8% per year to the bank (interest-only loan), incurring a total interest cost in the first year of $36,000.
  • His net rental income for the year, after other expenses such as agents’ fees, council rates, land tax, repairs, maintenance, building insurance and other allowable expenses, is $15,000.

Because John’s net income from the property ($15,000) is less than his interest expenses ($36,000), he has to find a way to meet the shortfall and pay the bank from his other income (probably his salary). But, in addition, negative gearing allows John to offset his net loss ($21,000) against his income tax.

Although investing in a negatively geared property leaves John with a lower overall net income for the year, the tax breaks from negative gearing mean his income tax bill is also lower. Table 1, below, sets this out as an overview.

John's negative gearing example
No investment
property ($)
With investment
property ($)
Salary (gross) 90,000 90,000
Net loss from property Not applicable 21,000
Assessable income (A) 90,000 69,000
Tax payable (B) 25,200 17,085
Net income 64,800 51,915
Difference in annual tax paid 8115 less with negative gearing
Difference in take-home pay 12,885 worse off with negative gearing

Table notes

(A) For simplicity we assume John has no other tax deductions.
(B) Calculated using 2006 – 7 income tax rates including the Medicare levy.

 

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