Negative gearing is a strategy that is used to stimulate the property market, usually in times when the economy is struggling and the government of the day is looking for ways to give it a kick-start. It has the effect of allowing any losses on an investment property to be a tax deduction, and for that reason alone, for people on the top tax scale, it has been very attractive. Essentially, negative gearing encourages investors to buy rental properties with little of their own money, and borrowing most, if not all, of the funds, usually in the form of a mortgage to purchase the rental property.
To the unwary, this sounds too good to be true, and for some people, it is. The fundamental issue in any negative gearing situation is that the tax benefit only happens if a loss is made on the total net result. For investors who are able to absorb that loss, there is no pain. However, as with anything in Brisbane real estate, caution should always come first, and only after understanding all the facts should the first time investor consider negative gearing.
Historically, investors who negatively gear their investment properties are in it for the long haul, and the patient ones have done well buying into the market when it was depressed, holding the property for some years, then selling it to cash in the capital gain. Along the way, they have been able to use their tax losses on the property or properties to reduce their taxable income, so they have effectively had two bites of the cherry.
What must be understood here, however, is that a loss is still a loss. On a negatively geared property, the loss occurs when the total rental income from the tax year is not enough to cover the cost of operating the property. When the total cost of the mortgage including interest and bank fees, agent fees, repairs and maintenance, rates and any other expenses is more than the amount of money collected from the rent, the property owner has to make up that shortfall with their own hard-earned cash.
If that shortfall is within the budget of the investor, and allows them to gain some tax benefits, all is well. If, however, something happens to interrupt the flow of income, for example, the Brisbane property management market experiences a glut of rental properties and there is no tenant for several months, the investor still has to pay the mortgage. If this becomes an overwhelming burden, then negative gearing is not the right vehicle for this particular investor.
Negative gearing is a legitimate tax and investment strategy for investors who have some capital behind them. It is a risky strategy for new players in the market who are already stretched with existing lifestyle commitments. Remember the old saying – only gamble with money you can afford to lose.