The executive rental market in Australia is an attractive proposition for property investors. In some parts of the country, executive tenants are willing to pay up to $3,000 a week for the right luxury properties, so it's unsurprising that many investors have their eye on this lucrative market. Like any other type of real estate, executive property investors should carefully consider the tax implications of any purchase, including the effect of negative gearing. Learn how negative gearing affects the value of your investment, and find out why this important tax break is under fire.
How negative gearing works
Gearing is a term that property investors commonly use. In fact, gearing simply refers to the process of borrowing money to buy an asset, including property. A significant proportion of property investors have to take out a loan for a property that they intend to lease out and, of course, everyone hopes to make an annual return on their profit.
To make a profit, you must receive an annual rental income that exceeds the cost of any interest that you pay on your loan. As such, you can end up in one of three gearing states, as follows:
- Positive gearing means your annual interest is less than your annual property income – an overall profit
- Neutral gearing means your loan interest equals your rental income
- Negative gearing means you are paying more in interest than you make in rental income.
At face value, negative gearing doesn't look good because it seems as though you aren't making any money from your property investment. The good news is that you can take advantage of negative gearing in your tax return and still see an overall profit.
Using negative gearing as a tax break
Australian tax regulations allow property investors to offset losses made by negative gearing against other taxable income. For example, if you make an overall annual loss of $20,000 on your executive rental property, you can offset this against any other income to cut the amount of tax you pay. In real terms, this tax break often means that you don't actually make a loss.
It gets better, too. While negative gearing allows you to offset the cost of these losses against your income, your executive property is likely to increase in value. As such, even if (on paper) you make a loss from your executive property every year for ten years, you can offset the value against tax AND benefit from the increase in the property's value over that period.
Unsurprisingly, some property investors use this situation to their advantage. For example, some people may take out finance that exceeds what they can realistically receive in rental income knowing that they can offset the losses against tax and that benefit from property value increases in the longer term. Unsurprisingly, this situation has led to criticism from many people.
Why people oppose negative gearing
Critics of negative gearing argue that the system artificially increases property prices. In turn, this price issue makes it harder for first-time buyers and creates an environment that only benefits wealthy property investors.
Australian government data seem to support this theory. In 2011/12, Australia was home to 1.9 million property investors, with an overall net rental loss of nearly $7 billion. Unsurprisingly, a 2014 review of the Australian financial system recommended reforms of negative gearing tax breaks.
The future for negative gearing
The Australian government is unlikely to withdraw negative gearing tax breaks without reasonable notice. While experts say the move could save $5 billion, any sudden change could cause financial damage to millions of investors. As such, the government will need to carefully consider the long-term impact of any changes in this tax break.
Executive property investors should carefully consider the implications of negative gearing. Before you invest in a property, make sure you fully understand the likely net income effect you will realise from your investment. Use an online calculator to get a quick impression of the effect this investment will have on your personal finances. It's important to consider your contingency plans, so that you know what you may need to do if tax reforms alter this popular tax break.
Many property investors in Australia rely on negative gearing tax breaks to secure a long-term investment, so it's worth getting expert financial advice before you buy an executive rental property. For executive property investors looking to buy more expensive properties, the risks and benefits of negative gearing can seriously affect the long-term investment prospect. For more information, contact a company like Joyce Property Investments.Share