Is Rental Property a Good Form of Investment? What is Negative Gearing?

When it comes to building wealth and securing financial futures, there's no shortage of investment options to consider. Among the myriad choices available, two perennial favorites stand out: real estate and shares. Both avenues offer unique opportunities and challenges, making them worthy contenders in any investor's portfolio. Here, we'll delve into the pros and cons of real estate investment and perhaps explain a conclusion on why you should (or shouldn’t) invest in them.

The main advantages and disadvantages of Real Estate Investment are listed below.

Pros:

Tax Advantages: One of the most enticing aspects of real estate investment is its tax benefits. Real estate allows investors to deduct expenses such as mortgage interest, property taxes, and depreciation. Additionally, any net loss incurred on real estate can be deducted against taxable income, providing a significant advantage for tax-conscious investors.

Tangible Asset: Owning real estate provides investors with a tangible asset that they can see, touch, and control. This sense of ownership can be reassuring, particularly during times of market volatility when intangible assets may seem more uncertain.

Income Generation: Real estate offers the potential for regular income through rental payments. Whether it's residential or commercial property, rental income can provide a steady stream of cash flow, making real estate investment an attractive option for those seeking passive income.

Cons:

Lack of Liquidity: One of the primary drawbacks of real estate investment is its lack of liquidity. Unlike shares, which can be bought and sold with relative ease on the stock market, selling real estate typically involves a more lengthy and complex process. This illiquidity can pose challenges for investors who may need to access their funds quickly.

High Initial Investment: Acquiring real estate often requires a substantial initial investment, including down payments, closing costs, and ongoing maintenance expenses. This barrier to entry may deter some investors, particularly those with limited capital or resources.

So, What is Negative Gearing and Why is it magical?

In short, negative gearing in rental property refers to a situation where the costs associated with owning and maintaining the property, exceed the rental income generated from tenants.

To put simply, it means rental expenses > rental income. This is what is understood by majority of the public. We’d like to call it, cash negative gearing.

However, there is another twist to it, of what we like to call tax negative gearing.

We will use the following example to better explain. We have rounded up the figures and tax rates (30%) for simpler explanation, with the assumption of the capital works and depreciation yearly total being $10,000

John bought a property in Mandurah, for $400,000, and immediately rents it out.

Annual cash rental income is $20,000, with annual cash rental expenses being $20,000.

This would mean, property net cash position is $0. (capital works and depreciation expenses are not included in the calculation, since they are not “cash expenses”)

 If we add a tax negative gearing twist to this by deducting capital works and depreciation, we would reach a negative $10,000 loss position. With the yearly deduction of the capital works and depreciation and John’s tax rate being 30% - This would result John with an additional $3,000 tax refund every year.

See this magic? $3,000 tax refund every year for the next 10 years is $30,000. This difference could propel him into greater wealth.  

One important consideration is that – these capital works and depreciation will need to be added back for capital gain calculation when the property is disposed of. However this is still better overall! (In short, you would generally benefit 50% more if you claimed capital works and depreciation annually when compared to not claiming them, i.e. Would you pay $15,000 to get $30,000?)

Please get in touch with us if you require any assistance.

Disclaimer: The information contained in this website is general in nature and does not take into account your personal situation. You should consider whether the information is appropriate to your needs and where appropriate seek professional advice. Taxation, legal and other matters referred on this website are of general nature only, and are based on interpretation of laws existing at the time and should be not relied upon in place of appropriate professional advice. Those laws may change from time to time.