Negative gearing explained: what it means, what you save

Negative gearing is one of the most talked-about tax strategies in Australian property investment, and one of the most misunderstood. Here's how it actually works, and how to calculate what it's worth to you.

What is negative gearing?

A property is negatively geared when its rental income is less than the costs of owning it, including interest repayments, council rates, insurance, property management fees and depreciation.

In Australia, this loss can be offset against your other taxable income, usually your salary. The result is a lower overall tax bill, which partially offsets the shortfall you're making on the property each year.

How is the tax benefit calculated?

The ATO uses what's called the differential tax method. It compares your tax liability with and without the property loss, and the difference is your benefit.

Your actual tax benefit depends on your marginal tax rate. Higher income earners get more back because more of the loss is sheltered at a higher rate. Someone on the 45% bracket saves nearly twice what someone on 19% saves from the same loss.

What expenses are deductible?

The following are generally deductible for Australian investment properties:

• •Loan interest (the largest deduction for most investors)
• •Council rates and water charges
• •Property management fees
• •Building and landlord insurance
• •Repairs and maintenance
• •Strata or body corporate fees
• •Accounting and legal fees related to the property
• •Depreciation (Division 40 and Division 43)

When does negative gearing make sense?

Negative gearing works best when:

• •You have a high marginal tax rate (37% or 45% bracket)
• •You expect the property to grow significantly in value
• •The shortfall is modest enough to be sustainable
• •You have other stable income to absorb the loss

Negative gearing does not turn a bad investment into a good one. A tax saving of $5,000 per year does not help if the property loses $30,000 in value. The tax benefit is a partial offset. It won't rescue a poor choice of property. It also works differently depending on your ownership structure. In a trust, for example, losses are trapped and cannot offset your personal income.

How ProfitPie calculates negative gearing

ProfitPie uses the differential tax method, the same method the ATO uses. Enter your income, and it determines your exact marginal rate, calculates the property's total deductions including depreciation and stamp duty impact, and works out your annual tax benefit.

It also projects this benefit over 30 years, because as interest rates, rental income and your own income change, so does the gearing position of the property.