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Ben Kingsley

11/03/2016
Blog post by Ben Kingsley

The financial impact of negative gearing

With all the debate around negative gearing, I thought it was time in this how to session to actually look at the number. The dollars and cents behind what a decision like changing Negative Gearing would have on a personal circumstance. So it’s important that we take a look at that and unpack that story so we can bring those facts to life. What upsets me the most about some of the commentary out there around negative gearing is that people are saying, you run this thing at a loss so you can get a big capital gain and that’s smart investing. That’s just crazy stuff.

I mean who would invest $1 so they can recoup 40 or 38 cents back in the losses that they are making it.

It does not make sense to me so what I wanted to do was go through this case study and you obviously won’t be able to see the numbers here but I am going to jump into the numbers and step through line by line so you can see the financial impact and then you can form a view. Remember negative gearing is not a strategy, it’s just part of the overall decision that an investor or someone going into business will make. At the end of the day, it’s being part of our tax system for over a hundred years. And it’s important to understand that as an investor I am investing for the long term but early on, I may make some losses. No different when I start a small business. So I want to show you what those financial impacts are and then obviously when the property turns from negative to neutral and then positively geared. Let’s take a look at numbers and conclude for ourselves.

So here we are in our property wealth planning simulator, taking a look at the cash flow impacts of no negative gearing versus the current laws which includes negative gearing. In this modelling assumption, we want to unpack that for everyone. So the salary income is assumed at $120,000 per year and that’s increasing at 3% pa. Living expenses are assumed at $5,000 per month, again, increasing at 3% pa. The market value of the investment property is assumed to be $500,000, increasing at 6% pa. Funds borrowed to purchase that property is assumed at 90 % loan to value ratio with an interest rate of 6%. All feature surpluses are assumed to be held in an offset account to reduce interest payable on the loan. Gross rental income for the investment property is assumed to be 4% of the value of the property, increasing at 4% each year. Properties are assumed to be occupied and providing rental income 92%, so an occupancy rate of 92%. Effectively for four weeks of a year and it is going to be vacant. Property management fees are assumed to be 7.7% of the gross rental income and ongoing costs associated with the property including rates, insurance, and maintenance are assumed to be 1.5% of the initial value, increasing at 3% per year. No allowances and this is a really important one. No allowances has been included for potential tax deduction that may be available because it’s a depreciating asset. This is a really important one for me because what I want to see in the ATO data that has been provided and scrutinised is, how much of that depreciation have they included in terms of the cost or the losses or the so-called tax that the government is missing out on in terms of government revenues. So it’s really important to understand it.

Let’s take a look at how the no negative gearing policy works overtime, so let’s unpack columns. Years, we’ve got twenty years the property value increasing over time, we’ve got the rental income coming through; we got the loan balance decreasing over time, annual expenditure, interest expenses, total cost and here’s negative cash flow. So this is the negative component that we’re talking about. And you can see here that there is no tax benefit so it’s a tax loss. And that loss is carried forward until the property turns positively geared in just almost ten years and then the property start delivering us income, on which we are paying tax on.

So you can see the government does get their tax in the end of the day and of course if the asset is sold, there is further the tax revenue flows to the government.

With negative gearing, you can see the current situation so in this particular case, we got the cash flows coming through and it’s negative for 8 years before the property starts to turn positively geared. Again, the lower the borrowings that the investor will take, the shorter the period of time on the property would be negative and the quicker it will become positively geared and tax is paying on that. Now it is really important to understand that that’s the net cash flow positions so that’s the tax benefit that the individual tax payer would be benefiting from the early stages of owning that property. Bearing in mind that they are still operating that property at a loss. Ok, so that’s only recuperating a portion of the loss, the property is still running at a loss so if the property doesn’t improve in value over time. It’s going to be a pretty poor investment. Obviously, you’re holding the asset for the long term where you’ll see the value go up and you are also seeing that income starts to flow through, which means tax is going to be paid. So tax benefits and then the tax expense, and then the next cash flows that are coming through for that client.

It really goes to show that yes, when people are making decision, it is part of a discussion point in terms of the asset that they buy but no one goes into a business to run a business at a loss and property investment is no different. And this potentially illustrates that in terms of the net difference between having no negative gearing and having gearing on the property.

I hope you took some information from that particular case study. Now, everyone’s circumstances is different, different incomes will have different tax consequences, different performances in the properties will have different results. We understand that. But the most important thing to understand is that negative gearing is part of the overall fabric of the investment environment that we’re working. When we want to go into creating wealth, we should be able to claim any of the costs associated with that and then ultimately as we go through that, you will see at the demonstration there that eventually we start paying taxes because we are starting to generate positive incomes and property investment is for the long term.

So there you are, that’s our how to session for today but it’s important to also understand we have other great how to sessions from beginner right through to advance. And that’s all about building up knowledge and education for you to make informed decision about your personal circumstances and ultimately creating a better financial future for yourself. Thanks for watching.

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