Negative Gearing numbers revisited

[DanielG]

Hi All, I was redoing some numbers today and came across some figures that have confused me and was wondering if someone could clear things up for me.

The idea, as far as I know, is that negative gearing allows you to go to a lower tax brackets and is used for tax minimization purposes. Here are some numbers I ran, two scenarios, one where I am positively geared and another negative (I have a lot of cash on hand so both scenarios can be manufactured in my scenario)


Tax Rate 1 This is my current scenario

Salary $82,500.00
Investment -$15,000.00 (My loss last year across 3 properties)

Net Salary $67,500.00 (My untaxed salary after losses on property, so now my tax bracket becomes 4,650 plus 30c for each $1 over $37,000)

Base Tax $4,650.00
Taxable Income $30,500.00 30% (30c for every dollar
Income Tax $9,150.00

Tax Payable $13,800.00

TOTAL LOSS + TAX -$28,800.00



Tax Rate 2 Scenario 2


Salary $82,500.00
Investment $3,557.52

Net Salary $86,057.52 (So now my tax rates are $17,550 plus 37c for each $1 over $80,000)

Base Tax $17,550.00
Taxable Income $6,057.52 37%
Income Tax $2,241.28

Tax Payables $19,791.28

TOTAL LOSS + TAX -$16,233.76

So in these two scenarios, even though I have been able to reduce my taxes down by $5991.28, I still lose out via this strategy overall by $12556.

Can someone clarify how negative gearing is the better option? How this is a valid strategy? Am I missing something?

 

[Peter_Tersteeg]

So in these two scenarios, even though I have been able to reduce my taxes down by $5991.28, I still lose out via this strategy overall by $12556.

Can someone clarify how negative gearing is the better option? How this is a valid strategy? Am I missing something?

You're thinking the point of negative gearing is to save tax. This is incorrect.

The idea behind negative gearing is that you make a profit through capital growth, but it will cost you money to hold the property. If the value of the properties does not increase more than the losses, then you're loosing money and it's a pointless excercise.

Secondary to this is that rental income also increases over time, so eventually a cashflow negative property becomes cashflow positive.

 

[DanielG]

Hi Bear,

So are my numbers correct?

Should my strategy be to get into as much positive gearing as I can?

 

[Peter_Tersteeg]

I didn't do the numbers specifically, but the way you're calculating it looks sound, so it follows that the conclusion you've come to is accurate.

In an uncertain capital growth market, many people are looking for positive geared property, but there are also successful exceptions to this. You've got to find the strategy that's right for you.

 

[Ergophobia]

High cash flow properties are typically lower growth, although recent years would make you question this rule.


Run your numbers again and include a line for unrealized capital gain as well as investment income.

 

[buzzlightyear]

A correction on your numbers.

In your first scenario, including Medicare Levy, Flood Levy, your refund assuming the normal tax PAYE tax paid throughout the year, is $5016. Therefore, your $15,000 in losses is offset by $5016 making a net position of -$9,984

In your second scenario, including Medicare Levy, Flood Levy, your tax liability assuming the normal tax PAYE tax paid throughout the year will be $1,346. Therefore your $3887.52 in gains is reduced by $1,346, making a net position of +$2,211.52.

The cash-flow effects are obvious, but what is the expected future cash-flows and capital gains for the investments? That is the more pertinent question.

 

[Wishlist]

Here are some numbers I ran, two scenarios, one where I am positively geared and another negative (I have a lot of cash on hand so both scenarios can be manufactured in my scenario)


Tax Rate 1 This is my current scenario

Salary $82,500.00
Investment -$15,000.00 (My loss last year across 3 properties)

This sounds like you already own the properties and are considering pumping more cash into them.

If so, what is the 'cash on hand' currently being used for?
Would the returns or potential returns from the cash as it is currently used, or intended to be used for, (is it in shares?) outweigh the benefit gained from moving it into the properties, say using an offset account, and making them cash flow positive?

 

[DanielG]

Hi Guys,

Thanks for the info, appreciated.

I have an 100% offset account for one of the IP's to throw cash into it without getting it locked into it (ie I can freely move it about as needed).

I think we all agree we are in a flat to negative capital period, which means higher rents and higher cashflow needs to be the pursued strategy for the new few years.

In terms of opportunity costs, well, what else is there to invest in? Super? Nah...dont want to lock up cash for the next 40 years until I retire. Shares? Yeah right, look at whats happening in Europe, Japan and the USA. We have hit peak earnings and the only reason stocks are up is because of inflation. Gold and silver? Hmmm, maybe. Long term deposit account? Why place my money in a banking account when I have an offset account?

Anyone else have a viable strategy thats working?

 

[Lofty]

Hi Daniel

We build our portfolio on a mixture of (usually) negatively geared property that we think have good long term capital gain prospects and property that we buy and then on-sell with vendor finance. The vendor finance properties cover the negative cash flow on our buy & holds and give us fixed (locked in) capital gain.

If our crystal ball is correct ;-) and we get some long term capital growth, the buy & holds are our long term wealth.

Cheers, Paul

 

[DanielG]

Hi Lofty,

What are the downsides to vendor financing? I assume that if the buyers cant make good on their "lower payments" that you can kick them out and keep what they have already paid. But what are the downsides?

 

[Lofty]

Hi Daniel

Yes, just like a bank, we keep the payments we receive.

With regard to the properties we sell with vendor finance (VF), it is disappointing if there is a big jump in capital gain because you've actually committed to sell the property at '$x'. However we setup the transaction to cover the negative cash flow of our buy & holds and, while we might be getting lower capital gain from the properties we've sold with VF, they are serving their purpose.

Also, I believe the home loan default rate in Australia averages around 1.5% to 2%. Our experience with Instalment Contracts shows a default rate of around 4%.

Cheers, Paul