Tax Planning    Negatively Geared Rental Property

Negatively Geared Rental Property

A negatively geared rental property is where borrowed funds are used to invest in property and the income generated (at least in the short term) is less than the tax deductible expenses. This creates a taxable loss from the investment which may be offset against the taxpayer's other income (normally salary and wage income). This results in the salary and wage earner receiving a tax refund of part of the PAYG withholding tax they have had deducted from their wages over the year.

This is a profitable strategy if the investment grows in value (capital appreciation) each year, by an amount that is greater than the net cash out-flow (the taxable loss less the tax refund received, less the building write-off claimed). The strategy works best when the investments purchased produce stable income and steady capital appreciation each year.

Risks Involved when borrowing to invest include:

Income risk - The taxpayer loses their job or income source and cannot fund the taxable loss.

Capital risk - The investments purchased fall in value or just stay constant.

Investment income risk - The investment doesn’t produce the expected investment income, i.e. the rental property becomes vacant or the dividend paying shares stop paying dividends.

Interest rate risk – Interest rates on the loan could rise.

The typical rental loss is $11,000 and is calculated as follows:

Rent: (4% rental yield on average property cost of $500,000) - $20,000 pa.

Interest: (4% interest on $450,000 property loan) - $18,000.

Property management fees: $2,000.

Council and water rates: $3,000.

Insurance: $1,000.

Factors to consider:

  1. Calculate the estimated tax refund, cash flow, and return on the proposed investment (over a 1, 5 and 10 year period).
  2. Consider the income risk if you were to lose your job or income source and cannot fund the taxable loss.
  3. Stress test the cash flow to ensure it can cover interest rates rising 2-4%.
  4. If buying an investment property, consider buying a newer property to take advantage of the extra depreciation deduction.
  5. Do your research on the proposed investment, or consider using an expert.
  6. Consider prepaying 12 months interest to bring forward the deduction into the current year.