Negative gearing is a property development strategy that is least understood by many investors. It is often regarded as the investor’s best friend but when executed incorrectly can create significant financial headaches.
Negative gearing is a strategy where an investor buys a property in such a manner that the property costs are higher than the property income. That is, the yearly interest payable on the loan you have taken out to purchase the property and other related expenses involved in property maintenance exceeds the rental income generated by the property each year. With this, you experience a loss of cash however the tax system absorbs the effects of this loss, and ultimately the tax effects reduce your loss. So basically, your rental income and the tax man pay for your investment property!
Tax Benefits of Negative Gearing
The Australian Taxation Office (ATO) allows investors to offset losses incurred from higher property costs to property income against the income from any other source. This might seem very generous of the ATO, however, you must consider several other factors before thinking of using this strategy. When using negative gearing you must always try to balance your repayments. If you fail to plan this aspect effectively, you may end up losing much more than you initially intended.
The losses incurred in a negative gearing strategy are real, and you will need to physically overcome your tax shortfalls. You may have unrealised capital gains that are not taxable as long as you don’t sell the property. But the problem with an unrealised profit is that you cannot use it easily. Accessing your unrealised profit can be a painful and expensive task.
Negative gearing is an excellent property acquiring strategy but it is designed to incur losses. This means you need to continue to work in order to balance the losses. The strategy alone does not provide enough financial freedom. It definitely helps you build financial success but if you are the sort of person who seeks an early retirement, it is not a complete strategy for you.