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Understanding Negative Gearing: A Wealth-Building Strategy
When the term ‘negative gearing’ arises, many people tend to dismiss it, assuming it pertains only to the wealthy. However, this strategy can actually facilitate significant wealth accumulation and entrance into the property market, thanks not only to tax savings but also enhanced investment opportunities.
The Challenge of Rising Property Prices
With property prices escalating at a pace that far exceeds inflation, entering the market is becoming increasingly challenging. Delaying the decision to invest can lead to further financial setbacks, particularly for earners who are not leveraging negative gearing to their advantage.
What is Negative Gearing?
Negative gearing occurs when the costs associated with an investment property—like mortgage interest and other expenses—exceed the rental income generated from it. This situation results in a financial loss, which can then be claimed as a tax deduction against other taxable income, such as salary.
Example Scenario:
Imagine you own a property valued at $750,000, incurring $50,000 annually in expenses while earning $30,000 in rental income. Here, you would face a net loss of $20,000, which reduces your taxable income. If you are in the highest tax bracket of 47%, this equates to a potential tax refund of $9,400, effectively recouping nearly half of your costs.
While a loss can sound daunting, it is important to consider the appreciation of the property. Over time, assuming a long-term growth rate of 6.3%, the property could increase in value by around $47,250 each year—illustrating a beneficial return on investment despite short-term cash flow challenges.
The Accelerating Property Market
Australia’s property market has surged, with median values rising by 38.4% over the past five years—averaging more than $3,775 per month. For potential buyers trying to save for a deposit, this means that waiting could result in losses rather than gains.
Utilising negative gearing can make property ownership more affordable, which can enhance your borrowing capacity. With the strategy in place, the financial returns can be substantial, providing the resources necessary to secure additional properties or assets in the future.
Is Negative Gearing Right for You?
While negative gearing can be effective, it isn’t suitable for everyone. Considerations include:
- Cash Flow: You need enough disposable income to cover any short-term losses as you hold the asset.
- Deposit Funds: Access to sufficient funding through personal savings or equity loans.
- Investment Timeframe: Ideally, you should be prepared to hold the property for a minimum of 7–10 years to optimise the growth potential.
Choosing a quality property is essential, as is conducting due diligence to ensure that the investment will appreciate over time. Neglecting these factors could lead to holding a depreciating asset, which would negate the benefits of negative gearing.
The Cost of Waiting
Postponing your entry into the property market not only delays financial gains but could also increase future costs. For instance, if the value of a $750,000 property increases to $797,250 within a year, the incremental loan amount required grows alongside deposit needs. Additionally, waiting can mean missing out on tax benefits associated with negative gearing, culminating in costs exceeding $75,000 for just a single year of delay.
Conclusion
Negative gearing is not merely a tax avoidance tactic; it represents a strategy for leveraging available rules to facilitate long-term financial growth. As the cost of waiting compounds in Australia’s fast-paced property market, engaging with negative gearing could enable you to expeditiously acquire property, lower your tax obligations, and ultimately, build wealth more effectively.
Ben Nash is a finance expert, podcaster, and founder of Pivot Wealth. For personalised financial advice or help with investing, consider booking a consultation with Pivot Wealth.
Disclaimer: The information provided is general and may not suit your personal circumstances. Professional financial advice should be sought where appropriate.
