The positives of negative gearing

It’s a commonly used term and lots of property investors are doing it, but what exactly is negative gearing? The Australian Tax Office explains.

Many Australians are property investors, with the recent property boom making it more attractive to invest in rental property. A significant number of these investment properties are negatively geared – a tax strategy where investors make a net loss on their property which can be claimed against their other income to lower the amount of tax they pay.

What is negative gearing?
A property is negatively geared if it is bought with borrowed funds, and the net rental income (after deducting other expenses) is less than the interest on the borrowings. If you have this kind of rental loss, you may be able to claim a deduction for the full amount of rental expenses against your rental and other income, such as salary, wages or business income. If this means that your rental expenses would entitle you to a tax refund, you may be able to reduce your rate of withholding.

Negative gearing and capital gains tax
If you’re thinking of buying a negatively-geared rental property, it’s important to remember that while you may get an immediate benefit from negative gearing, you may have to pay tax on your property when you sell it. This is because any profit you make on its sale will be subject to capital gains tax.

Getting it right
When preparing your tax return, it’s important that you understand what rental expenses you can and can’t claim to ensure you don’t pay more tax than you need to. You also need to keep the right records to verify the deductions you’ve claimed.
There are three main types of rental expenses. Firstly, there are expenses that can be claimed as an immediate deduction in the year they were incurred. Examples of these expenses include advertising for tenants, insurance, maintenance of property and council rates and interest paid.

Secondly, there is a range of expenses that can’t be claimed as an immediate deduction, but can be claimed over a number of years as depreciation or decline in value. These may include depreciation to fixtures, such as boilers; the cost of capital works, such as improvements or initial repairs; and even those expenses incurred in taking out the loan to purchase the property, like loan establishment fees and mortgage preparation costs.

You can only claim deductions for the period that the property was available for rent, so if you choose to make the investment property your main residence after renting it for three years, you can only claim deductions for the three years you had the property available for rent.

If you only rent your property for part of the year (this may be the case if it’s a holiday home) then you have to be careful that you apportion costs correctly. This means you can only claim expenses for the part of the year that the property was rented or available for rent. You can’t claim any expenses for the time the property was not available for renting or being used by yourself.

Finally, there are some expenses which can’t be claimed as deductions at all. These are expenses not actually incurred by you, such as electricity and phone costs that are paid by your tenants. Buying (acquisition) and selling (disposal) costs also fall into this category. However, as most acquisition and disposal costs form part of the cost base of the property, they can reduce your capital gains tax liability when you come to sell.

Keeping it at arm’s length
In order to claim deductions on an investment property, your dealings with tenants and lenders must be at arm’s length. If you’re renting your property to a family member or a friend at less than the commercial value of the property, then you’re not acting at arm’s length, and you cannot claim deductions as you would in a purely commercial arrangement.

Apportioning your costs
If you rent your property for part of the year at commercial rates, and the other part of the year you rent to family or friends at a cheaper rate, you may be able to claim some rental deductions. You must however be careful that you properly apportion your costs – that is, you can only claim deductions for that period of the year when your property was rented at commercial rates.

Apportioning is important too when it comes to claiming a deduction for interest on borrowings. If you borrow to buy an investment property, but then spend 10 per cent of those borrowings on renovations to your main residence, you can’t claim the full amount of interest against your rental property. In this instance you would only be able to claim 90 per cent of the interest accrued, as 10 per cent of that interest accrued against personal spending.

Keeping records
It’s easier to get your tax right if you’re keeping good records, and this is very true of rental deductions. If you’re keeping good records, it’s much easier to understand which category your expenses fall into, and makes completing your tax return a much simpler task.

Rental income records must be kept for five years, and must be in English (or readily convertible to English). They should contain:

• the name of the supplier
• the amount of the expense
• the nature of the goods or services
• the date the expense was incurred, and
• the date of the document.
  

You must also keep records relating to your ownership of the property, as well as the costs of acquiring and disposing of it, for capital gains tax purposes for the whole time you own the property plus five years. This also applies to your main residence if you are considering buying a new residence and keeping your old home as an investment property.

For more information, you can download the Rental properties guide from the ATO website at www.ato.gov.au or call 1300 720 092 to order a copy.