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Case Study - Negative Gearing
David is interested in investing in an apartment; he has done his background research and found a property he thinks best suits his investment strategy.
Let’s look at the breakdown:
Table 1
| Gold Coast Property | |
| 2 Bedrooms, 2 Bathrooms, Unfurnished |
|
| Purchase Price |
$440,000 |
| Deposit (20%) |
$88,000 |
| Bank loan (80%) |
$352,000 |
| Interest Rate |
7.3% |
| Rented permanently | $470 per week |
| Scenario based on 3% Vacancy rate | $455 per week |
Table 2
| Income p.a. | Expenses p.a. | ||
| Rental (3%Vacancy rate) | $23,660 | Body Corporate |
$5,700 |
| Council rates |
$2,600 | ||
| Management Fees |
$1,849 | ||
| Insurance | $300 | ||
| Interest Bank |
$25,696 | ||
| Income | $23,660 | Expenses | -$36,145 |
| Total Income/Loss |
-$12,485 | ||
Without negative gearing, David is looking at a loss of $12,485 per year on this investment. However, there are tax deductions David is eligible for:
Table 3
| Possible Tax Deductions |
||
| Building Depreciation | The cost of a building is determined by a Quantity Surveyor | Calculated over a period of 40 years, depreciated at 2.5% pa |
| Fixture and Fitting Depreciation | Deductions depreciated over the life of fixture or fitting (7 – 10 years) | Including: hot water systems, carpets, ovens, air conditioners |
| Purchasing Costs | Expenses from the purchase | Including: bank fees, solicitor fees, lenders mortgage insurance |
| Expenses | Ongoing costs for the property | Including: maintenance and repair costs, council fees, water, insurance, interest on the loan, body corporate fees |
Table 4
| Davids Allowable Deductions (PA) | |
| Building Depreciation (approximately) |
$9,000 |
| Fixtures/Fittings Depreciation (approximately) |
$6,000 |
| Travel Expenses |
$1,000 |
| Accountant | $500 |
| Total Allowable Deductions |
-$16,500 |
If David is on a wage of $100,000 per year, the benefit of offsetting deductions means that David’s tax bracket has changed:
Table 5
| Income | Expenses | ||
| Personal Income |
$100,000 | Expenses |
$36,145 |
| Rental Income | $23,660 |
Deductions | $16,500 |
| Total Taxable Income | $123,660 | Total Allowable Deductions | -$52,645 |
| New Taxable Income |
+$71,015 |
||
Table 6
| New Taxable Income |
|
| New Taxable Income |
$71,015 |
| Tax applicable on PAYE $100,000 |
$24,950 |
| Tax applicable on PAYE $71,015 |
$14,855 |
| Possible tax refund |
$10,095 |
If we take David’s total loss on this property (−$12,485) and add the potential tax refund of $10,095, he is now operating on a loss (holding cost) of −$2,390 per annum. However, as the property’s rent increases over time, this shortfall will decrease and the property should eventually become positively geared. If David has chosen wisely, he should also reap the benefits in the long-term when he sells the property.
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