There are plenty of misconceptions when it comes to “negative gearing” and the effect it has on your tax situation. How is it that people can quickly go from one investment property, to four or more in such a short time?! Negative gearing refers to the strategy whereby the costs of owning & maintaining an investment property are greater than the income it generates (often due to interest on the mortgage). This is great for people on middle-incomes who want to try and bring themselves down a tax bracket, usually below the $90,000 bracket. The investor is also banking on growth in the price of the investment property over the medium-long term, to offset the income losses. The biggest drawback of this strategy is that it reduces your borrowing power, as your income is reduced. As a result, lending institutions won’t lend you as much. So if negative gearing makes it harder to borrow, how do you structure your investment to borrow more? The answer seems simple in theory, but sometimes more difficult in practice; and that is to positively gear your property. If negative gearing is when expenses are greater than income, then positive gearing is the opposite. When it comes to your tax, making a positive return on your property means your income is higher, and you are less likely to get a refund when lodging your tax return, however, it enhances your borrowing power. How can you use this to grow your portfolio quickly? Once you have one positively geared investment property, using this to grow your portfolio is far easier than getting that first investment. After 12-24 months of holding your first investment, discuss with your broker about getting the loan refinanced, particularly if there has been significant property price growth in that suburb. This means the lender will re-value the property, and potentially lend you more based on the value of that property, which, when combined with your higher income as a result of being positively geared, can help you get that second property. From here you simply repeat this process. Beware of the traps! Don’t over-extend yourself. A decrease in house prices can blow your strategy wide-open and leave you struggling to pick up the pieces. If you can’t do the research yourself, or don’t know enough about property, talk to a buyers agent who can do all the hard work for you. Don’t sell more than one investment property in a single financial year without talking to your accountant first, or you could find yourself with a very large and unpleasant tax bill. Your accountant can assist you in putting together a strategy to sell down your investment properties while also minimising your tax; but they can’t do this retrospectively! Only the interest portion of your mortgage repayments is tax deductible. Always consider the cash flow implications of any mortgage against an investment property. Your tax return may suggest you have a high income, but the reality is you’re struggling to make ends meet as a result of having less cash in your pocket. Your accountant or financial advisor can help you structure appropriately and minimise known risks.
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