close
close

The tax cut tactic will give Australian homeowners an extra $41,000

Stock image of houses from above.

Negative gearing could be your answer to a sustainable tax cut.

Borrowing money to invest comes with some serious tax benefits, with you being able to claim a tax deduction for the cost of borrowing money to grow your investments.

By borrowing to invest you can invest more than is possible with your savings alone And reduce your tax bill at the same time.

This is why negative gearing is one of my favorite strategies for saving taxes and building wealth.

Gearing means borrowing to invest. The negative part relates to the ‘cash flow’ of your investment, with the most common form of negative gearing in Australia being property investing.

If you borrow to invest and the total cost of the investment is less than the income generated, the cash flow is negative.

Now you may be wondering why on earth anyone would want to choose an investment that involves losing money, and that’s a good question.

There are two reasons. The first is the tax benefits, as the cost of your investment can be claimed as a full tax deduction (more on this below).

The second reason is that the income from your investment is only one part of the picture, while the other is your growth.

When you own an investment property, you receive income from the rental and then have to bear the costs associated with owning the property.

The largest costs are usually the mortgage interest, then you have ongoing real estate costs such as rates, insurance and maintenance.

I’ve included an example below of the cost of a $1 million investment property, assuming you borrow the full amount of the purchase ($1 million).

Mortgage rate of 6 percent = $60,000 per year

Ongoing real estate costs of 1 percent = $10,000

Total cost: $70,000 per year

You would then receive rent, and based on the Australian average of 3.7 percent this would equate to $37,000 in rental income per year.

So the net cost of your $1 million investment property would be $33,000 (income of $37,000 minus expenses of $70,000). You can see in this case that the ‘cash flow’ of your investment property is negative, meaning you are in a negative gearing situation.

If your income is more than $45,000 per year, your marginal tax rate + Medicare tax is at least 34.5 percent, meaning for every dollar of tax deductions you have, you’ll receive a $0.345 tax refund.

If your income and tax rate are higher, the tax deductions are even higher.

But assuming your tax rate is 34.5 percent, based on a negative gearing deduction of $33,000 in the example above, you’ll receive a tax refund of $11,385.

This brings the after tax costs to maintain your investment property from $33,000 to $21,615 per year

The obvious next question is why you would want to make an investment that will cost you almost $22,000 per year, and that question is fair.

The answer lies in the growth in value of the property over time.

In Australia, the long-term growth rate for real estate is 6.3 percent, meaning a $1 million property will increase by an average of $63,000 every year.

If you follow the numbers, you’ll pay $21,615 each year to receive a $63,000 benefit, meaning the net benefit to you is $41,385. every year.

The numbers stack up nicely here.

There are very few investments that will give you an extra $40,000 each year, lower your tax bill and use the rules to your benefit. Negative gearing can affect all three.

You should be aware that every time you borrow to invest, you are at risk.

Especially today, there are many people who were not as aware of this risk as they should have been when purchasing property, and with rising interest rates this poses a challenge.

When thinking about negative gearing (or any other investment strategy), it’s important that you take the time to understand your risks, manage them as much as necessary, and be smart in your planning.

Especially when buying real estate, you should always look ahead to ensure that you can afford the property not only today or tomorrow, but also in the years to come.

Negative gearing is a strategy that can further reduce your tax bill this year and every year, giving you more money to help finance your investments, or simply go straight to your lifestyle expenses.

At the same time, this strategy allows you to acquire more investments than you can get with your savings alone, and more good investments behind you means more growth in your wealth and wealth position in the future.

The strategy is solid for people who want to be smart and use the rules to their advantage to get ahead faster, but it does come with risks.

If you want to get results without adding even more stress and strain on your finances, you need to be smart about your planning and risk management.

But this risk can be managed well with the right approach, and if you get this strategy right, it will significantly accelerate your financial progress.