How does Negative Gearing work with property investment?

Here is an example of negative gearing in action.

Let?s say that you purchased a property for $300,000. This property is financed by a loan with an interest rate of 7%. So the annual interest rate is $21,000 ($300,000* 7%). You receive $15,000 per annum in rent from tenants and it costs you an additional $3,000 each year to maintain your property and pay council ad water rates.

The total income received is $15,000, but the total expense is $24,000. The investment makes a net loss of $9,000 per annum ($24,000 – $15,000). If you earn a salary of $90,000, your taxable income is reduced to $81,000. This will result in a tax refund of $3,330 at the end of the financial year.

So the net cash flow cost to you as an investor would be $9,000 less your refund of $3,330 which is $5,670. (This excludes other potential tax deductions such as depreciation).

Alternatively, rather than waiting until the end of the financial year to receive your refund, you can get your refund paid back to you on a pay per pay basis (tax can be deducted from you pay in lieu getting a refund at the end of the financial year). This is done by applying to the Australian Tax Office to reduce PAYG withholding payments. This will cut the weekly cost of the investment by $64 per week to $109.00 per week, which can help you maintain your cashflow.

When the investment property is sold after 10 years, the $300,000 property is paid off. If the property was sold for $600,000 a capital gain of $300,000 is made but only a net loss of $90,000 ($9,000* 10) was made over this period. Thus you are $210,000 better off from this investment plus $33,300 in saved taxes.

Depending on your marginal rate of tax, your situation may look similar to this: