Property Gearing Explained!

The election is over, the country has voted. And negative gearing is here to stay!

For property investors and homeowners, the term ‘negative gearing’ gets thrown around a lot, but what is it and how can property gearing affect your investment?

In the property and real estate industry, ‘gearing’ is essentially borrowing from the bank to buy an asset, and that asset generally is the invested property.

There are 3 ways a property can be geared:

Negative Gearing

When a property is negatively geared it means that the rental return of that #investmentproperty is less than your loan & interest repayments and all other outgoing expenses.

Neutral Gearing

This type of property gearing occurs when both income and investment expenses are equal and there is no overlap of one or the other.

Positive Gearing

Positive gearing is the same as its counterpart, but yes you guessed it, opposite! When your #investmentproperty is positively geared it essentially means your rental return is higher than your repayments.

How can I make money out an investment property?

If negative gearing means you’re losing money, then how can it be good?

Negative gearing an #investmentproperty can help you financially through several ways.

When the property value increases

Capital growth is the increase in value of your property over time and can be achieved in two main ways. Firstly, you can improve the value of the property through renovation or upgrades which generally requires investment (capital improvement).

The second is simply an increase in the property value over time (capital growth). When you buy a property it’s important to consider the growth prospects of the area to maximise capital growth potential over time of your portfolio.

Rents increase turning it to positive geared

As rents increase over time, an investment property can easily turn positively geared, especially if you are paying P&I repayments on the mortgage reducing interest. Positively geared property frees up cashflow to increase your portfolio and/or reduce debt depending upon your strategy, and of course stage of life.

For the purpose of minimizing tax

If you’re looking to minimise tax, then property is a great strategy to do this using negatively geared property!

Let’s explain a bit more…

Basically, if your investment property expenses exceed the rental income then the difference is a deduction against your taxable income.

In the below example the expenses exceed income by $15,815 and therefore this investor’s taxable income would be reduced by the same amount.

Rental Income 28000
Less expenses:
Interest -22000
Borrowing -375
Rates -2300
Insurance -1300
Body Corp Fees -2800
Management Fees -2240
Repairs -900
Less Depreciation
Building -6500
Plant & Equipment -5400
-43815
Net Rent -15815

The important part to note is depreciation. Depreciation is an ‘on paper’ or ‘soft dollar’ cost which basically means it doesn’t cost you money throughout the year.

When purchasing property, it’s always a good idea to consider deprecation, especially if purchasing property after the 7th May 2017 as the laws have changed restricting plant and equipment depreciation on second-hand properties.

All in all, the best investment property is the one that combines all the above. When purchasing property, the key points to remember are growth areas, good rental demand and maximum depreciation. With a bit of careful planning you really can have it all…!

Let us know your thoughts on property gearing and get in touch with ABA Tax today for a free chat!

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