The purpose of this blog article is to discuss the concept of “negative gearing” and its practical implications for investors in property.
We also include 5 helpful tips for our readers at the bottom of the article.
What is negative gearing?
Often the focus in media and politics is on one aspect of negative gearing – the tax deductions claimed on interest expenses incurred in acquiring and holding investment properties.
In fact, negative gearing extends beyond just tax deductions for interest expenses; it also covers tax deductions for capital works” and “capital allowances”. This makes negative gearing through property investment attractive to taxpayers with high incomes because a wide range of property-related tax deductions may be claimed to offset their tax liability from other income.
Tax deductions are available for loans used to acquire investment properties; no tax deductions may be claimed on loans for properties used for private or domestic purposes (e.g. a family home).
For foreign investors in Australian property, there may be limits to how much tax deductions you may claim (although in practice it will only apply to foreign investors purchasing borrowing substantial funds to acquire property).
Capital works are, broadly, a deduction which is intended to reflect the wear and tear of structural improvements to land. For typical investors in property, annual capital works deductions are claimed at 2.5% of the total construction costs of a building.
Example – capital works
Taxpayer A incurs $400,000 in the construction of a residential investment property.
On completion of the property, Taxpayer A is entitled to claim annual capital works deductions of $10,000 over 40 years.
Capital allowances are, broadly, the tax depreciation claims which are intended to reflect the wear and tear of depreciating assets; it must be noted that it is not available to the extent a depreciating asset is used for private or domestic purposes. Investment properties are typically stocked with various finishings such as kitchen appliances, air conditioning and solar power systems in the case of freestanding buildings; these are all valuable sources of tax deductions, particularly in new investment properties.
There are two methods of claiming capital allowances:
- prime cost (“straight line”); and
- diminishing value.
I need not remind readers that the principle of time value of money suggests a dollar today is worth more than a dollar in the future.
5 Tax tips for investors in property
Here are 5 tips that readers may find valuable in the process of investing in property:
- Strict time limits to amending tax returns: if you have purchased an investment property and you have not been claiming any capital works or capital allowances, you have not maximised your tax deductions; further, you might be under-claiming your potential tax deductions annually (see tip no.2 below).
You generally have a time limit of two years from the date of an assessment to file an amended tax return to claim those tax deductions – claim your deductions in the applicable time limit or you will lose the cash-tax flow benefit of claiming them as early as possible. For this reason, stay-at-home partners with negatively geared investments should also lodge tax returns to secure future tax losses.
- Building allowance reports: we recommend our readers obtain reports for each of their investment properties to identify all sources of tax deduction claims. We can assist you with finding a reliable service provider.
- Buying negatively geared properties in the name(s) of investors with the highest tax rate: putting aside momentarily the issues of asset protection or land tax etc, a negatively geared property will yield the most efficient tax outcomes when purchased in the name of the investor with the highest marginal tax rate. Don’t forget – income tax is only one factor to consider when buying property!
- A new (or newer) investment property has higher tax depreciation potential than an old property: if you consider two comparable investment properties, one new and the other an older building, we expect the new property will achieve greater tax depreciation potential. Again, tax attributes are only one factor to consider when investing in property.
- Prioritise paying off mortgages on the family home: it is more tax efficient to repay a mortgage on your family home than the investment property. Consider converting to an interest-only loan on your investment property and repaying your mortgage on the family home at a faster rate.
We hope this article has provided our readers with something useful. Please feel free to leave feedback or any queries on the article below.