When purchasing an investment property, one of the many things you will have to consider is how you plan to gear the dwelling.
Blogger: Bob Korver, owner, Mortgage Choice
Will your property be positively geared so that the income you earn from it outweighs the cost of owning the property?
Or, will it be negatively geared, meaning the cost of owning the property is more than the income it generates each year?
Before making a final decision, it is important to understand what positive and negative gearing is and how each option may impact your bottom line.
Positive gearing is when the rent from your investment property is higher than costs such as loan repayments, interest, property maintenance and rates. Positive gearing is very popular in the current environment because rental rates are strong, while interest rates are sitting at historical lows.
While positively-geared properties may sound ideal – given that your dwelling is constantly making you money – it is important to note that any profit you earn from your investment is considered ‘taxable income’.
It is for this reason that a lot of landlords of positively-geared properties decide to set funds aside in order to cover the tax they will pay on their investment each year.
Negative gearing occurs when the cost of owning a rental property outweighs the income it generates each year. This creates a taxable loss, which can normally be offset against other income including your wage or salary, to provide tax savings.
Let's say, for example, you own a rental property generating $25,000 in rent each year. The costs of holding the property, including mortgage interest, come to $30,000. This gives you a taxable loss of $5,000, which you can use to reduce the tax payable on your salary.
If you know in advance that your investment will record a loss over the financial year, you can apply to the tax office to reduce the amount of tax taken out of your salary. This is called PAYG Withholding Variation and it can provide a real boost to your personal cash flow. Speak to your tax adviser or accountant for more details.
But while there are some obvious tax benefits associated with negatively-geared investment properties, this method of gearing isn’t without its pitfalls.
When you negatively gear your property, you still record a loss. And a loss is a loss is a loss.
Before you commit to negatively gearing your investment property (or multiple investment properties) it is worth considering what the repercussions of doing so are.
These are not questions that should be answered quickly or treated lightly. Take the time to do your due diligence and know how you would cope if any of the above scenarios came true.
If you are confident that you could easily handle any losses in income etc, then you are on the right track.
How you gear your investment property is not a decision that should be made lightly. Before making any decisions, it is important to consult with a professional.