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How negative gearing can reduce your tax bill
If you own an investment property, you can use negative gearing to pay less tax. How does it work and how soon can you start saving money??
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This article was fact-checked and reviewed by Lloyd Edge, an accredited buyer's agent, licensed real estate agent and the author of Positively Geared. Content has been updated for 2021.
Negative gearing is when the cost of owning an investment property (interest and expenses) is more than the return you receive on your rental property (rental income). In other words, it's costing you to own the property. In Australia, property investors can use negative gearing to reduce their tax bill significantly.
It's a useful benefit, but it has become a controversial policy. Learn how negative gearing works, examine the risks involved and gain some strategies to maximise the profits from your investment property.
What is negative gearing?
An investment property is negatively geared if the net rental income (after deducting expenses and depreciation) is less than the interest on the borrowed funds.
The outcome of a negatively geared property is that a net rental loss arises. You could borrow money to buy an investment property, renovate the property and then cover a range of maintenance costs. At the end of the financial year, you may discover that the annual rental income you generate from your investment is less than the expenses you incurred.
This is not good, obviously, but you can benefit from this loss by offsetting it against the income you earn from other sources. The end result is that the loss from your negatively geared property can be offset against your salary and other incomes, so from the ATO's view, you are effectively earning less and therefore will pay less tax at the end of the financial year.
While common for property investing, negative gearing can also be used for other financial investments such as shares and bonds.
Negative gearing – a hypothetical example
- Ahmed buys a $400,000 investment property with a deposit of $100,000.
- He gets a loan for $300,000 from a lender.
- He collects $300 per week in rent, or $15,600 per year.
- The loan is an interest-only mortgage with a rate of 4.2%. The initial interest charges are $1,050 per month, or $12,600 per year.
- Ahmed spends $1,000 on maintenance in the first year, $2,100 in strata fees and a further $2,000 in property manager fees, plus $1,000 on insurance.
- Together, these costs plus interest charges total $18,700. This is $3,100 more than he collects in rent.
Result: Ahmed is negatively geared and can deduct the difference from his taxable income.
How do I calculate negative gearing loss?
To work out your negative gearing loss, you will need to follow these steps:
- Add up your property income. This will consist of the rent you collect from the property. Simply multiply the weekly rent by 52.
- Add up your property expenses. This includes interest payments on the mortgage, maintenance costs and property-management fees.
- Deduct depreciation. Depreciation is the loss you see from the decrease in value of the building and certain assets within the property. Examples of items you could depreciate would be carpets, drapes, hardwood floors and appliances.
A good accountant can help you set up a depreciation schedule to figure out the amount you can deduct for depreciation each year.
What are the investment expenses that you can claim as a deduction?
Generally, you can claim a deduction for your expenses associated with the management and maintenance of an investment property, including the interest you pay on loans. If your asset is negatively geared, you may be able to deduct the full amount of rental expenses against your rental and other income, including your salary and wages.
Depending on your circumstances, you may also be able to claim depreciation against the property's rental income. As a general rule, property investors can claim deductions in three main categories:
- Revenue deductions. You can claim revenue deductions such as the interest on the money you borrow as well as ongoing maintenance fees.
- Capital items. Large items such as a plumbed-in dishwasher in a rental property are subject to depreciation over time and can be claimed over several years.
- Building allowances. Generally, you can claim for building allowances such as for depreciation over time or for building works.
You can visit the ATO website for a comprehensive list of deductible expenses.
Additional deductible expenses
- Body corporate fees
- Costs associated with borrowing (e.g. stamp duty and charges on your loan)
- The cost of advertising for tenants
- Insurance
- Fees and commissions charged by property agents
- Land tax
- Repairs and maintenance costs
- Interest you are charged on your loans and other bank fees
- Cleaning services
- Gardening and lawn mowing costs
- Pest control expenses
- Council and water rates
- Capital works costs
- Depreciation on plant and equipment
What are the risks involved with negative gearing?
Just like any investment strategy, negative gearing has risks. Borrowing money to fund an investment is risky in itself, and you should be fully aware of what negative gearing involves before you pursue this strategy. Consider the following risks before you commit to a negative gearing strategy:
- What if you have a cash-flow shortage?
- What if you can't find a tenant and the property is left vacant for an extended period?
- What if the property market takes a dive and you are unable to achieve the capital gain you had planned?
- What if you are unable to make your loan repayments?
- What if tax laws change and negative gearing is no longer as financially viable for your unique needs?
However, there are steps you can take to minimise the risks associated with negative gearing. The best way to minimise your investment risk is to do plenty of research when choosing your investment property and select a property that is likely to rise in value.
Make sure your income is high enough to cover interest repayments and maintain your investment property, even in less-than-ideal circumstances. Speak to the experts such as a financial planner, a tax accountant and a mortgage broker to ensure that you make a sound financial decision.
What place does negative gearing have in the Australian market?
Negative gearing has been a popular strategy for Australian investors for many years, but it's also a source of controversy.
The following are some of the arguments against negative gearing:
- It encourages property investment and reduces housing supply to home buyers (and increases prices).
- It benefits asset-rich investors over buyers, helping the rich get richer.
- It encourages risky investment.
The following are some of the arguments in favour of negative gearing:
- It's a modest fringe benefit for investors, many of whom are only on moderate incomes.
- It encourages investment in property and spurs housing construction.
- Removing it could raise rents (by raising investors' costs) and even hurt property prices by lowering investment.
It's a complicated topic, and experts commenting on negative gearing in the media often do so with the interests of a specific group in mind. The whole thing is further complicated by the fact that many Australians are property investors and many are both renters and investors.
More property investing guides and advice
- Property investing tax strategies. Negative gearing is a strategy property investors use to offset their short-term losses in the pursuit of long-term capital gains. This requires the ability to absorb some cash-flow losses, but a savvy investor can structure their property investment in such a way as to maximise its tax effectiveness.
- Capital gains tax. Another important piece of the negative gearing puzzle is the capital gains tax (CGT) concession. This allows investors who have held their property for at least 12 months an exemption on 50% of their CGT bill. Coupled with negative gearing, the CGT discount makes property an extremely tax-effective investment strategy. Learn more about minimising CGT.
- Getting your foot on the property investment ladder. While property might be a tax-effective and attractive asset class for investment, first-time investors can feel intimidated by the perceived difficulty of buying their first property. Before you wade into the world of property investment, there are some important investing strategies to keep in mind.
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Ask an Expert
Hi,
In the situation when I can’t find a tenant for my investment property and the property is left vacant for an extended period, Are the repayments made during this period tax deductible?
Thanks,
Raghu
Hi Raghu,
Thanks for reaching out.
You can still claim expenses for your investment property, such as the interest on loans, as long as the property is genuinely available for rent.
According to the Australian Taxation Office (ATO), if a property is genuinely available for rent, it must be advertised to potential tenants and tenants must be reasonably likely to rent the property. For more details, please speak with a tax accountant or visit the ATO’s rental property expenses to claim guide.
All the best,
Belinda