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Negative Gearing - it's not to your benefit!
By Naomi Warne
The concept of negative gearing has been originally developed to
encourage real estate investment in Australia by allowing any income
losses from property investment to be deductible from other income as a
tax benefit. This means that the taxable income of the owner will be
reduced after the deduction and therefore the total tax payable is also
reduced.
In view of the fact that many of the profits from property
investments are usually obtained as a capital gains at the time when
the property is sold, but do not generate positive cash flow from
rentals during the course of the holding period, negative gearing
therefore came in to address this issue.
You lose either way
However, the flaw with negative gearing lies in its concept as well. If
an investment generates a positive cash flow, the increased income will
make the investor liable to pay more taxes as well. In the end, the
investor loses either way. If he makes money from positive cash flow,
he has to pay part of it off in taxes, while negative cash flow will
take money out of his pocket. Therefore, with a negative geared
property, it is not possible to get a positive cash flow and pay less
tax at the same time.
No guarantees on property value appreciation
Investors who are encouraged to put their money into negative geared
property should think twice. As these properties are expected to
generate profits only through capital gains, the value in capital gains
should then be greater than the total losses incurred over the course
of the holding period. However, there is no guarantee that the value of
the property will appreciate, or at least appreciate enough to cover
your losses. Also, you can’t possibly use your expected future
profits now as it is not been realized yet.
Beware of attractive property packages
Who gains from this then? Well, investors who are seeking investment
property will tend to seek out property developers or sales agents. In
order to make a property seem attractive, they are packaged with
elaborate financial models with expected returns on investment.
However, commissions and profits to the developers have all been
packaged into the sale price. With this, investors end up paying
premium price for a property with negative cash flow, which is used to
pay for hefty commissions to sales agents and developers.
The disadvantage of property depreciations
Another aspect that should be watched out for would be property
depreciation for taxation purposes. While it is true that depreciation
is applied and is used for tax deductions, however, accumulative tax
deductions for depreciation costs on property with appreciating value
may cause capital gains taxes to be large. This is because the greater
depreciation you apply onto the value of your property, the lower its
value will be on paper. Therefore, your difference between the sale
price and the book value of your property at the time of sale will be
great. This leads to larger taxes imposed onto you.
Do not purchase because of tax benefits
Finally, making a property investment requires careful planning and
consideration. Extra caution must be put in especially when a property
is projected to generate a negative cash flow. In the end, tax benefits
should not the main reason for property purchase. You may end up losing
a great deal of money in the end.
For more information, please visit Mortgage Mall
Australia. About the Author Naomi Warne of Around the Corner Real Estate Dealers, Sydney, has helped her clients with profitable property investments and numerous tax benefits. Having started as a real estate agent, Naomi has established herself as an analyst and property consultant.
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