Don’t let negative gearing be the focus

As a property investor, unless you’ve been hiding under a rock in recent months, you would have heard about the Australian government’s potential proposed changes to property tax via negative gearing. It’s certainly caused a tsunami of debate, with everyone weighing in with their two cents worth.  Along with a myriad of opinions, statistics and economists, it’s certainly an area that has raised the hackles of opposing sides as they go head to head on the pros and cons.

As a refresher: an investment property is negatively geared when the costs of owning it (and this includes interest on the loan, bank charges, managing costs, maintenance, repairs and depreciation) exceed the income it produces. Since the costs of producing an income are generally deductible against a taxpayer’s other income, property investors can effectively offset some of these expenses against their wages. It’s interesting to note that negative gearing is nothing new, given it was first introduced with the Income Tax Assessment Act back in 1936.

Being able to offset losses against income is certainly a tool that’s been useful for many Australian tax-paying investors, especially when starting their journey with higher loans and LVRs. It reduces cashflow and doesn’t hurt the hip pocket as much. But let’s remember that negative gearing shouldn’t be the overriding focus when considering any property investment . It’s just a result of how a property has been financed, and allows many investors to be out of pocket less than they would be, without any tax benefits.

Overall, what you are ultimately banking on when you have a negatively geared investment is that it will grow in sufficient value at a rate which not only covers your annual out-of-pocket expenses but also covers the cost of selling, any CGT (capital gains tax) that will be due if you sell, plus enough of a profit to make all the hassle worthwhile. Eventually, given time and rising rents, you should be aiming for the property to be positively geared (where the rental income will exceed the expenses of  holding the property).

But there’s also the opportunity cost of your money being used elsewhere. In other words, what else could you be doing with your cashflow if it wasn’t tied up in a particular property investment?

Borrowing to invest, particularly if the investment will suffer losses to hold (and be negatively geared) is something you need to consider carefully, both in terms of the quality of the investment and whether the cashflow arrangement will suit your lifestyle and other financial commitments.

Personally, I don’t like to rely on negative gearing for my investments to be affordable. Above average capital growth needs to be the focus, and keeping this in mind as the goal in any property investment, will ensure that better decisions are ultimately made.  Assessing each investment property on its own merits needs to be made, and considering any tax benefits as a side bonus.