What is negative gearing? An example
Tuesday, November 28th, 2006You hear so much about negative gearing, but how exactly does it work?
Suppose you take out a loan for an investment property. Repayments are $2,000 per month.
You rent the house to a tenant, who pays $1,200 per month.
You have to find an extra $800 per month out of your own pocket just to cover the repayments. That’s negative gearing.
But what are the benefits of negative gearing? Let’s keep it simple. We won’t include agents fees or repairs or anything else.
At the end of the year you have paid $24,000 off the loan. $20,000 of this was interest. Your tenant has paid $14,400 in rent.
Interest is a cost.
So far, your costs are $20,000. Note this. It is not the amount of money you repaid, it is the cost. That’s a very important difference.
$20,000 less $14,400 is $5,600. This is the amount you can offset against other income—$5,600.
Thus, if your salary is, say, $80,000, you can reduce the amount of money you pay tax on by $5,600.
In 2006 you would have paid:
Tax on $80,000 = $21,900 (+$1,200 medicare = $23,100)
Tax on $74,400 = $19,548 (+$1,116 medicare = $20,664)
Given that you have already paid tax on the full $80,000, you will get a refund of $2,436 A nice tax return, but not $5,600.
People talk about the benefits of negative gearing, but you have to ask yourself, “Is it worth it? Is it worth paying out an extra $800 per month ($9,600 per year), just to get $2,436 back.
Not necessarily.
If you are negatively gearing just for the tax benefits, then you’re doing it for the wrong reasons.