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Common $23,800 tax trick can be 'recipe for disaster': 'Losing money'

Getting into the property market can be an expensive gamble, but if you nail this powerful strategy, it could leverage you to further success.

Ben Nash
·Contributor
Updated ·6-min read
Ben Nash has broken down the benefits of negative gearing, despite the strategy being to lose money.
Ben Nash has broken down the benefits of negative gearing, despite the strategy being to lose money. (Ben Nash/Getty)

Negative gearing is one of the most popular Australian money strategies. It has helped millions of people save tax and grow their wealth.

But it’s common for people to lose sight of the fact that negative gearing means one thing. You’re losing money.

‘Gearing’ simply means borrowing money to invest.

So any time you borrow money and invest it, you are ‘gearing’.

You can gear into any investment such as shares, crypto, gold, or anything else - but the most common investment that’s used as part of a gearing strategy is investing with property.

The ‘negative’ part of negative gearing refers to the income of your investment.

When you invest, your investment will typically generate income.

When you invest through shares, your shares pay an income in the form of dividends, and when you invest through property, you receive rental income.

On the other side of the equation, any time you’re borrowing money to invest, you will have borrowing and interest costs.

Further, you may have other ongoing costs, such as management fees on a share portfolio, or in the case of property, you will have ongoing property expenses like rates, maintenance costs, and management fees.

When you follow a gearing investment strategy, if the net income of your investment is negative it means the total costs are higher than the total income - this is referred to as negative gearing.

And if the net income of your investment is positive (income more than costs) this reflects ‘positive gearing’.

Under the Australian tax rules, your investment income is added to your employment income and taxed at your marginal tax rate.

But under the negative gearing rules, this also works if your investment income is negative.

This means you receive a tax deduction for the net income from your negatively geared investment, and you end up paying less tax as a result.

Under the current tax rules, if your income is above $45,000 p.a., your marginal tax rate is at least 30 per cent (and up to 47 per cent if your income is higher).

This means that if you follow a negative gearing strategy, you will receive a refund of at least 30 per cent.

BREAK IT DOWN: If you have a negatively geared investment that is costing you $10,000 each year, you receive a $10,000 tax deduction.

This in turn delivers a $3,000 tax refund - meaning the after tax cost of your investment is only $7,000.

The Australian Taxation Office (ATO) is effectively funding part of your investment for you.

So many people get blinded by the tax benefits on offer through negative gearing, and lose sight of the big picture.

Ultimately, if you’re following a negative gearing strategy it means your investment is costing you more than it’s making you in income, i.e. that you’re losing money.

You might be forgiven for wondering why on earth anyone would want to have an investment that’s costing you money, even if it is saving you tax.

The answer lies in the fact that the income from your investment is only one side of the equation - the other side is the growth in the value of your investment over time.

The long term growth rate on Australian property over the last 150 years is 6.3 per cent, which means that on average over the long-term the value of properties is increasing at a relatively consistent rate.

This growth is the reason you would want to have an investment that’s costing you money.

Because when you choose a good property investment, this growth will cover the cashflow cost you pay, and deliver you profit on top.

BREAK IT DOWN: Consider this example. You purchase a $500,000 investment property using a 20 per cent deposit, funding the purchase with a $400,000 mortgage.

The ongoing mortgage costs at a 6.5 per cent interest rate are $26,000 p.a., and on top you have ongoing property costs like rates and strata of around $5,000 annually.

This brings your total costs to $31,000 each year.

On this property you receive rental income at the Australian average of 4 per cent, meaning your rental income would be around $20,000 p.a.

In this case, the net income of your property investment would be $11,000 p.a., meaning you’d have a negatively geared investment.

You’d be able to claim an $11,000 deduction, and assuming a 30 per cent tax rate you’d receive a refund of $3,300, meaning the total after-tax cost of your investment would be $7,700 each year.

Then based on the long-term property growth rate of 6.3 per cent, over time on average you’d expect this property to increase by around $31,500 each year.

So to bring this all together, you have total after-tax costs of $7,700 and a growth upside of $31,500, reflecting a net benefit to the property owner of $23,800 every single year.

You can see from this why negative gearing is such a popular strategy.

You can see from the example above that the numbers work fairly nicely in your favour as a property investor.

But there’s one big underlying assumption that’s critical to the strategy actually working.

The property you choose to invest in must grow for you to benefit from a negative gearing strategy.

To say this another way, if you choose an investment property that doesn’t grow, you will be out of pocket for the ongoing property costs, and have no upside benefit to cover these costs, not to mention actually making a profit after covering your costs.

Most people lose sight of this when they think about buying property, but this is a recipe for disaster.

And while there is no one way that’s guaranteed to work, sticking to the tried and tested strategy of buying quality properties in quality areas with strong supply vs demand fundamentals goes a long way.

Negative gearing is a powerful strategy that can allow you to use the bank's money to invest more than you could with just your savings alone, save tax at the same time - and ultimately get ahead with your money faster.

But you will be losing money following a negative gearing strategy, so it’s crucial you choose a property that will grow.

If you’re considering using this strategy, take the time to plan well and you’ll be rewarded.

Focus your time on choosing a good property and you’ll go a long way to setting up your investment for success.

Ben Nash is a finance expert commentator, podcaster, financial adviser and founder of Pivot Wealth. Ben is about to release his third book, Virgin Millionaire; the step-by-step guide to your first million and beyond.

Ben runs regular money education events to help you save more and invest smarter. You can check out all the details and book your place here.

Disclaimer: The information contained in this article is general in nature and does not take into account your personal objectives, financial situation or needs. Therefore, you should consider whether the information is appropriate to your circumstances before acting on it, and where appropriate, seek professional advice from a finance professional.