One of the basic principles of Australian Tax is that costs incurred in the course of earning income are generally tax deductible.
When it comes to borrowing for an investment, this principle also applies.
Many Australians borrow to invest, particularly in property, which is a concept known as “gearing”. Ideally, people invest with the intention of making a profit, either year on year through an income stream, or upon sale of the investment.
However, if the costs of borrowing exceed the income arising from the investment, the investment is “negatively geared”.
This is important, as under current legislation this loss can be offset against other income such as salary and wages, therefore providing tax savings. Negative gearing has both benefits and pitfalls, and it is important to evaluate these before committing to an investment.
A quick case study to explain how negative gearing can affect your tax position.
Assume that you earn $75,000 before tax in the 2019 financial year from regular employment.
You also have a rental property that brings in $20,000 of rental income, but has associated expenses (repairs, insurance etc) of $7,000, depreciation of $5,000, and associated interest from the mortgage of a further $15,000.
Excluding the ramifications of the rental property, your initial $75,000 would have resulted in $16,892 of tax (including Medicare levy).
The net rental income is -$7,000. Under the current legislation, we can reduce our $75,000 to $68,000 which results in a tax bill of $14,477 (including Medicare levy).
The overall result from all this is instead of an investment loss of $7,000, you have a loss of $4,585- a saving of $2,415. Further, as $5,000 of your expenses were from depreciation and not cash paid out through expenses, you are ahead in real cash by $415*
The Labor government has signalled its intention to change these rules by abolishing this basic principle for all investors, excluding those who invest in new Australian property. This means that if your expenses exceed the income as in the above situation, there’s no taxable benefit to claim. Importantly, this policy has been examined by the Tax Institute of Australia and they announced that not only would this policy cover investments in property such as houses, but also other investments such as shares that also produce income.
Whilst this policy might sound fair initially, it appears to have far wider ramifications than intended.
Assessing an investment for both the tax and financial benefits is an important step, and not one that should be ignored. If you are thinking about investing through gearing, call us to book a no obligation meeting to discuss this further.
*Net Cash movement after tax = $20,000 (income) – $7,000 (general expenses) – $15,000 (interest) + $2,415 (Tax refund) = $415