NEGATIVE AND POSITIVE CASH FLOW FOR PROPERTY – NEGATIVE GEARING EXPLAINED

With the lowest mortgage interest rates for over 50 years, most investors in property are finding the rental income is greater than the outgoings for the investment so in such cases, the property is known as being “positively geared”.

Negative gearing, as described by Wikipedia, is a practice whereby an investor borrows money to acquire an income-producing investment property, expecting the gross income generated by the investment, at least in the short-term, to be less than the cost of owning and managing the investment, including depreciation and interest charged on the loan (but excluding capital repayments). The arrangement is a form of financial leverage. The investor may enter into this arrangement expecting the tax benefits (if any) and the capital gain on the investment, when the investment is ultimately disposed of, to exceed the accumulated losses of holding the investment.

To service a negatively geared property an investor has to cover the loss created by the shortfall in outgoings compared to the income from the property.

Because an investment property is considered a business, any losses made by the investor can be used to offset the investor’s tax liability from other investments or income.

The Income Tax Assessment Act 1936 - Sect 128b allows a tax payer to reduce their tax liability for their weekly PAYG tax deductions to allow for the loss made from owning a negatively geared property instead of waiting until the end of the tax year to obtain a tax refund.

Capital Gains is the main reason for buying a negatively geared property, so it is very important to buy a property that is negatively geared in an area or suburb where there is every likelihood of properties achieving the highest possible capital growth.

Of course, with a capital gain comes Capital Gains Tax which eats into any income gains made from the sale of a property.

Tax depreciation is an additional tax liability reduction strategy but it is best used for brand new properties which have the highest capital depreciation potential

Properties with the greatest chance of Capital Growth are usually found in suburbs in major cities close to the CBD – within 10 km - or beaches and are the most expensive compared to properties in the outer suburbs, but properties with the highest chance of a capital growth cost more than other properties.

Investing in a property must meet personal needs and the investor investment strategy, age, income, tax liabilities and ability to service a loan must all be considered.

For example, an investor may not consider investing in the Broken Hill property market as a good choice but in a 10 year period an investment property in the “Silver City” produced a rental return (yield) of over 8% and a 10% growth rate. But during these 10 years the property market in that City may have gone through a “catch-up” and that capital growth may not be achieved for the next 10 year period.

Of course, a property can be positively geared if an investor only borrowed 50% of the purchase price, but would be negatively geared for an investor who borrowed 80% of the purchase price because the loan repayments would be higher.

The real problem facing investors with negatively geared properties is the shortfall may grow if the property became un-tenanted or the weekly rent reduced – this has occurred in new suburbs that have been constructed around the fringes of Brisbane and the Gold Coast in the last 2 years.

Another problem facing a negatively geared investor, particularly in the current economic environment, is the possibility of losing employment which may result in the investor having to sell the investment property before achieving any chance of a capital gain.

For these reasons, a positively geared property may be the best investment strategy for most property investors. And if the investor can afford to buy a positively geared property in an area of sustainable capital growth, then the investor has the best of both worlds.