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.