Negative gearing is a common real estate strategy for investors, especially relevant in dynamic markets like Tasmania. It’s a situation where an investor purchases a property, and their rental income is less than the expenses, including interest on the investment loan, rates, maintenance and management fees. The result is a net loss, offset against other income, ultimately reducing the investor’s taxable income at tax time. In this post, we explore the advantages and disadvantages of this approach.
Pros of Negative Gearing
Tax Benefits
Investors in higher tax brackets may find a reduction in taxable income desirable as it can lead to tax savings. This is the most immediate benefit and can be claimed annually as a reduction in taxable income.
Capital Growth Potential
Gaining a foothold in historically high-growth areas like Hobart and Launceston may be worth a short-term loss. As the asset appreciates over time investors may choose to accept a negative yield asset due to the potential long-term capital gains.
Increased Investment Capacity
For some, negative gearing may be a more accessible option for entering the property market than purchasing a home to occupy. For an investment loan banks will factor your expected rental income into their assessment which may allow you to break into the market sooner than you would have in an owner-occupier scenario.
Cons of Negative Gearing
Cash Flow Risk
Negative gearing, by function, means you are running the property at a loss. This can put you under increased pressure should major repairs or periods of rental vacancy. You will have to find a way to cover these costs on top of your regular contributions and expenses which may put you in an uncomfortable situation.
Tax Dependence
The benefits of negative gearing depend on current tax laws. Changes in ATO regulations could significantly impact the viability of the investment.
Market Volatility
Property markets are subject to fluctuations. Negative gearing can be risky in unstable economic climates if the market stagnates or declines, investors could face both capital loss and ongoing expenses.
The Verdict…
Negative gearing is a choice that will depend greatly on your objective and personal circumstances. While it offers tax benefits and potential growth, it carries risks like market volatility and cash flow challenges. Investors in Tasmania’s real estate market should weigh these factors carefully. Consulting with financial experts and real estate professionals can provide tailored advice for individual investment strategies.