Why buy Negatively Geared Properties? I think the calculations are wrong

[manoj]

When you purchase a property for investment purposes and when interest is more that rental income, or when gearing is negative, it creates a loss which can reduce other income such as wages and reduce the tax which we pay.

Tax rate above $80K income is 40% + medicare levy


So If my loss is $10,000 (excluding depreciation) i can expect my refund to be $4150 which means that i will have to pay only $5850 from my pocket to own the property.

In other words :
I have to earn $10,000 and then pay tax of $4150 and then when i am left with $5850 - i will pay to the bank as interest.

This means;
The cost of the property is $10,000 and not $5850, however after attending 100's of seminars, i am told the cost of the property is $5850!

Can someone tell me, If I am right or wrong.....

[dan c]

Your overall position without property

Income $100,000
Tax $ 27,500
Net $ 72,500

With property, negatively geared, showing $10,000 loss without depn.

Income $ 90,000
Tax $ 23,350
Net $ 66,650

Difference is $5850.

[dan c]

Originally Posted by manoj

In other words :
I have to earn $10,000 and then pay tax of $4150 and then when i am left with $5850 - i will pay to the bank as interest.

This means;
The cost of the property is $10,000 and not $5850, however after attending 100's of seminars, i am told the cost of the property is $5850!

Can someone tell me, If I am right or wrong.....

The point you are missing is the $4150 that you are paying in tax on your earnings, is refunded at the end of the year.

[manoj]

So it is right to own the property - it costs me $10,000

from $100K - my income is down to $90,000

or in other words i will pay $4150 in tax $5850 in cash to own the property = $10,000 - if i did not have the property - my income was $100K - but because I own a negatively geared property - my income has come down to $90,000

If I salary sacrificed $10,000 and that income was not taxed in my SMSF (due to a loss in the fund or due to death benefit payments etc) and pay no tax on my contribution, my income will be more by $10,000

Which means that the property actually costs $10,000 and not the after tax effect of $5,850!

[wobbycarly]

Originally Posted by manoj

So it is right to own the property - it costs me $10,000

from $100K - my income is down to $90,000

or in other words i will pay $4150 in tax $5850 in cash to own the property = $10,000 - if i did not have the property - my income was $100K - but because I own a negatively geared property - my income has come down to $90,000

If I salary sacrificed $10,000 and that income was not taxed in my SMSF (due to a loss in the fund or due to death benefit payments etc) and pay no tax on my contribution, my income will be more by $10,000

Which means that the property actually costs $10,000 and not the after tax effect of $5,850!

Look at it this way. You are effectively investing $10k pa after tax in your property. The government likes this so much that they will pay you back the tax you already paid on that earned $10k, so your investment only costs you $5850 after tax.

And I'd think it fairly rare that your super contribution would not be taxed. If it is taxed, then your $10k becomes $8500 going into super and $1500 going to tax.

And then the question becomes, will your $8500 in super return more than the $5850 in your property?

[BV]

Manoj

I know that all this is not new to you so what's the point of your question and poll?

In another post you signed as
Superannuation Technical Advisor to .....
SMSF Specialist Advisor
SMSF Specialist Auditor
B. Bus (UTS) PNA FTIA LREA SSA SSAud

[BV]

IMO all 4 options are correct btw

[JamesGG]

For 2009 FY:

Without property

Taxable income: $ 100,000
Net rental: $ 0
Tax: $ 29,600

Money in pocket: $ 70,400


With property

Taxable income (before property): $100,000
Net rental: -$10,000
Tax: $25,350

Money in pocket: $64,650

Therefore, property costs you $5,750 to hold, after tax.


Salary sacrificing:

Taxable income: $ 90,000
Net rental: $0
Tax: $25,350

Money in pocket: $64,650

Same deal as the above 'with property' scenario, only you've kept the $10k in super.

Then it will depend on the particular investor whether they can generate better profits (ie, expected capital gains) by losing $5,750 in negative gearing, or whether $10k in super will provide a better return. Either way, leftover cash for personal use is the same.

[dan c]

Manoj, if you have the property, your after tax income is $72,500. If you don't, your after tax income is $66,650. The difference is $5850.

You are not taking into account the tax saving of $4150 in your calculations.

So you are not right.

[JamesGG]

Originally Posted by JamesGG

For 2009 FY:

Extrapolating a little...

With property incl depreciation:

Taxable income (before property): $100,000
Net rental (cash): -$10,000
Net rental (non-cash): -$10,000
Tax: $21,100

Money in pocket: $68,900
Net cost of property: $1,500


$1,500 is also the expected tax in most cases for $10,000 sacrificed into super. So cost of both forms of investment, it would seem, then becomes approximately the same.

[manoj]

Thanks JamesGG and Dan C

The cost of the property is $10K - i think we both agree on this
because if I did not own the property - my income will be higher

But i end up sacrificing only $5850 as the tax is $4150 (governments contribution to me owning the asset), In other words, bank gets $10K as interest has to be paid, I pay $5,850 as i get this less in my pocket and the Government gets $4,150 less tax from me

The figures are
my income $100,000
less bank interest 10,000 (due to my negative gearing)

= my income $90,000

less tax which is now reduced by $4,150 due to reduction of income
I lose $5,850

So i am right = the cost of owning the property is $10,000 and not $5,850

I am not saying the cost is $10K to me or to the Government - I am saying "my income has gone down by $10K" - the cost of owning the investment property is $10K. Period.

Further more if i have to pay only $5,850 - first i have to earn $10,000 then pay the tax of $4,150 and then pay $5850 to the bank as interest. You see, to pay the $5850 (after tax cost) to the bank - i have to earn it first.

So when i go for dinner with my family the bill is $100 at the restaurant. So i have to earn $171 (approx) - then pay the tax of $71 and then pay to the restaurant owner. So the cost of my dinner is $171 and not $100.

As i cannot claim cost of dinner $100 in my tax return, the same way i cannot claim $5,850 in my income tax return = this is my after tax cost!

Since i cannot claim $5,850 (after tax cost) as a tax deduction, it is the same as going for dinner - so my dinner (owning the property) will cost me $5,850 plus - i have to earn $10,000 pay the tax @ 41.5% or $4,150 and then i will be left with a $5,850 which I have to pay to the bank and not be able to claim the $5,850 in my tax return.

In other words it costs 71% more (of $5,850 or $4150 or $71 for a $100 dinner) to go for dinner (or owning property) then what you pay to the restaurant owner (bank interest).

So the property has to go up by $10,000 in the year for me to come out quits or $100,000 (in today $'s) in the next 7 years @ rate of 3% cumulative inflation - which means that if my property purchased in 2003 is not already up by $100,000 i have lost $100,000?

If the dinner costs $100 each time - instead of losing $10,000 by owning the property - i can take my family for dinner $58.5 times and not 100 times because i have to pay the tax first - that is - before i can go for dinner.

So I am right - the cost of owning the property is $10,000 and not $5,850 - which means all those people in the seminars are lying! Is that right?


Manoj Abichandani
SMSF Specialist Advisor
SMSF Specialist Auditor
Tax Agent, FTIA, PNA, REA

[Hooray]

You can't double count the 4,150 tax. If you didn't have the property, you'd pay it to the tax office. If you have the property, you don't have to pay the tax office but have to 'pay' the bank instead. Either way, the 4,150 is not an extra cost to you. So the only 'extra' expense of owning the property is the 5,850.

Remind me not to use your services with super funds if you can't even figure out how negative gearing works. James and Dan's figures are crystal clear. If you can't figure that out, I fear for your clients.

[wobbycarly]

You're adding the tax back in at the wrong place.

Your income doesn't change. You simply choose to invest $10k of your $100k income into property (to cover the shortfall...). So at this stage, tax is irrelevant and your INCOME doesn't change. (And let's not complicate this with ITWV!)

Then when you submit your tax return, the govt, decides that the $10k you INVESTED should not be taxed so you get back the tax ($4150) you already paid on that.

Simple, no? Go back to Dan_c, post#2. Look at after tax, money in your pocket.

[dan c]

OK, I'll try again. You are confusing yourself with after-tax and before-tax dollars. If you only owned the property, and spent your money on nothing else, the money in your hand would be $5850 less than if you didn't own the property.

This is because the property expenses are tax deductible.

Your GROSS income is down $10,000, but you are forgetting to add back the tax savings of $4150. It is NOT the same as going to dinner, as dinner is not tax deductible.

In other words it costs 71% more (of $5,850 or $4150 or $71 for a $100 dinner) to go for dinner (or owning property) then what you pay to the restaurant owner (bank interest).

No, because you are forgetting that you recieve the $4150 back as a refund of tax, or at least it reduces your tax bill.

If instead, using the same figures, you put $10,000 into super, becasue of the tax deduction, your after tax income is only $5850 less, because of the tax deduction (if eligible). This is because the super is deductible, reducing the tax by $4150.

[battler]

Originally Posted by manoj

So when i go for dinner with my family the bill is $100 at the restaurant. So i have to earn $171 (approx) - then pay the tax of $71 and then pay to the restaurant owner. So the cost of my dinner is $171 and not $100.

71% tax seems a tad high to me?