How Investing Borrowed Money for a Loss Can Benefit You Later
If you are a real estate investor, you may already be familiar with negative gearing. A property is considered negatively geared when it is generating a loss from ongoing or one-off costs related to the investment.
While it may seem counterintuitive, there are a number of advantages to this type of situation for investors seeking to build capital. You can often deduct some of your investment from your tax bill, and the loss you incur may leave you eligible for tax refunds.
But first, let’s take a look at the concept in more detail.
What Are the Costs?
Ongoing costs are typically paid on a monthly or yearly basis. These may include property management fees and the costs of building maintenance. The interest on mortgage payments, utility bills and land tax are also relevant expenses. Others may include the cost of insurance and accounting fees.
One-off expenses may include your initial deposit and fees associated with setting up a home loan. It also applies to stamp duty, and fees paid to solicitors and conveyors involved in the deal. You may also have to pay an initial cost for connecting the property to water, gas and electricity. Other estimated upfront fees tend to fall into this category as well.
Your building may fall in value depending on market activity. Though this kind of loss does not appear on a cash flow statement, it is still relevant for tax purposes.
How Does Negative Gearing Help?
Negative gearing can help an investor absorb some of the cost associated with their investment and, in some cases, even profit from them. For example, most of these costs are deductible from taxable income, which could put the investor in a lower tax bracket. Investors should note, however, that making the most of these benefits takes time.
Why Use Negative Gearing?
While investing for a loss may seem a fool’s errand, there are a number of situations where this strategy is advantageous.
There are many areas in Australia where demand for homes and potential for growth are high. An investor can buy many negatively geared properties with the expectation that their value will eventually grow beyond the cost of their investment.
Property value is not the only area for potential growth either. There is also rental income, which in some cases, may produce positive cash flow. While a positively-geared property is no longer losing money, it may lose out on some tax benefits.
Given the complexity and attention required of this strategy, you should talk to an expert before moving forward.
What’s the right home loan for Negative Gearing?
For many years, investment property borrowers have been advised to consider choosing an interest only loan. This advice was in part to maximise the tax-deductible expenses associated with a property, in order to maximise the negative gearing benefit.
However, the recent increase in the cost of interest only loans means that this type of loan may be costing borrowers thousands of dollars a year. Use uno’s investment property loan calculator to find out whether you could save money by avoiding an interest only loan for your investment property.
How Do You Calculate Negative Gearing?
Here’s where a negative gearing calculator may come in handy. A calculator first determines cash flow by deducting your ongoing and one-off expenses from your rental income. It then estimates how all this will affect your tax bill. The next step is to talk to an expert who can confirm that the figures are correct and help create a plan.