Positive Gearing question.

[lostis]

Hi All,

I have been doing alot of research via books and such regarding various techniques of positive and negative gearing.

Basically i understand the concept that the basic idea of Negative Gearing is for tax breaks and also a wait for Capital Growth.

Positive gearing is more or less a way of gaining an income through property investment.

If my interpretation of these concepts are wrong, please let me know.

My question is, how do people justify the positive gearing when inevitably it could possibly put u in a higher tax bracket and your earnings from the rent will mostly go to the tax man anyway?

I have gone through and searched through this forum for an explanation but could not find one or have overlooked it. If there is one cuold you please also point me in that direction.

 

[Hoffy]

My question is, how do people justify the positive gearing when inevitably it could possibly put u in a higher tax bracket and your earnings from the rent will mostly go to the tax man anyway?

Even at the highest marginal tax rate (which now only impacts about 3% of the population) you aren't in a position where most of your earnings go to the tax man.

I don't know about others, but positive cash flow is my objective. I prefer making money over losing money, not withstanding CG of course.

 

[attrill]

You are correct in your understanding of positive and negative gearing. Negative gearing is popular with those who have a high tax bill, but as each property makes a loss and the owner has to make up the shortfall, it is not long before the bank says you have run out of borrowing power.

If you buy positivly geared property and you have a higher income after each property is added to the portfolio then there is theoretically no limit to the number you could buy.

For some the strategy is to buy a positivly geared property in an area with little capital growth, and offset this with a negativly geared property in an area with a greater capital growth.

Everybody's situation is different but mine is to buy negativly geared property in a great position whilst I want to work to offset my tax and then when I want to stop working sell a property or two to turn the whole portfoilo positivly geared and live off the income.

Hope this helps.

 

[buzzlightyear]

My question is, how do people justify the positive gearing when inevitably it could possibly put u in a higher tax bracket and your earnings from the rent will mostly go to the tax man anyway?

How do you justify a new promotion at work when you are going to be paid more (and yes taxed more)? Ultimately isn't your take home pay increasing? Same for positively geared investments

Mostly to the taxman?! PAYG marginal tax rates for incomes between $34,000 to $80,000 is 30% plus 1.5% Medicare Levy You are keeping 68.5% of any income gained. For incomes $80k to $180k, you are keeping 54.4%.

Paying tax is sure sign you are making money. Isn't that the purpose of investing?

 

[Perp]

Um, I'm with buzz - making a profit sounds better than making a loss to me, for sure.

If you just want to reduce your tax, you could just gift your entire salary to a recognised charity, and you'd pay no tax.

 

[Peter_Tersteeg]

Positive gearing may put you in a higher tax bracket because you're making more money. This is usually considered a good thing.

Negative gearing lowers your tax bracket because you're making a loss somewhere, so it's potentially not a good thing. You may actually be making money and be positive cashflow due to depreciation and other tax deductions however, but these are also things you can benefit from if the property is positively geared.

If you're property is positively geared and you have to pay more tax, don't be alarmed because it means you're making money from the property.

Personally I'd like to have a million dollar tax bill. You have to make a huge amount of money to pay $1,000,000 tax.

 

[buzzlightyear]

Personally I'd like to have a million dollar tax bill. You have to make a huge amount of money to pay $1,000,000 tax.

Peter, didn't realise that mortgage broking was so lucrative!

 

[GoAnna!]

Personally I think the ony justification for negative gearing is excellent capital growth to offset the loss. If you are not getting growth how exactly is it an investment given you had to put your hand in your pocket each week to prop it up. Lose your job and the negative gearing benefits. Ouch!

Negative gearing = loss

Postive gearing may or may not mean you need to pay tax. It is possible to be making cash money from rents but depreciation etc takes you into a paper loss. The best of both worlds. If you manange to also get good capital gains on this property the you're laughing. Your servicability will go a long way with the banks. Positive gearing means more money in your pocket.

Positive gearing = profit

 

[want2bewealthy]

The way I see it is,
if youre making money from an investment and still getting good capital growth then good, but if youre not loosing much youre still ahead, say 10k per annum out of your pocket to hold 1 mil worth of property, it only has to increase by 1% over the whole portfolio and youre just scraping by, if it increased by 15% then you made a big profit, still a little better if you didnt have to pay anything from your own pocket though, if youre close to retirement then negative gearing isnt really for you but if youve bought time then theres no worries.

 

[lostis]

Thanks for the informative responses guys.

I myself have always seen positive gearing as the way to go, just couldn't get my head around the tax thing thats all.

but i guess your right that the big picture is more important, being that the more your taxed, means the more money your making

Just gotta find ways to write everything i spend of as a tax expense.

 

[Tramsnod]

The way its been explained to me is:

Negative gearing = I pay a dollar to get .30c back in tax = .70c loss

Positive gearing = I earn a dollar and pay .30c tax = .70c profit.

I know the theory, I just haven't got my 4 IP's round to positive yet.

I guess the plan is still buy as many as I can and when I decide to retire at least I have some IP's to play with that will allow me to work out wether I keep them sell all, or some of them etc.

 

[Carl]

Hi Lostis,

This is the concept which confused me when i started looking at property investing. I heard that a lot of people were 'investing' in property that they were making a big loss on, in order to 'reduce their tax bill'. I still don't get it, because as far as i understand unless the property increases in value by a fair bit, the reason their tax bill is decreasing is because they are losing money??? Disturbs me when i see ppl talking about property costing $500k+ and only getting ~$300/week. Personally i like 5%+ yield, so that i can sleep easy and not have to look at prices too much to ensure growth is greater than holding costs

On another note, Goanna, my first property (bought Dec 07) is in the situation you mentioned. Rent is more than interest & rental expenses but depreciation gives me a paper loss. Very happy, as a couple of months ago i was going to dip my hand in my pocket a bit each pay packet (which was a drop in the sea anyway).

I guess some people like speculating on massive negative property whereas others like positive geared property, or in my case a property which was slightly negative geared. What a big year....

 

[Jonathon]

As others have pointed out, negative gearing isn't good unless you're getting a capital gain in excess of the cash cost each year. In fact even if your capital growth, allowing for CGT, is equal to your cash cost, you're still behind as you could have put that cash to an alternative use and got a better return.

I think there are (very broadly) two types of positively geared investments.

Type 1 is the type which yields 5% plus and probably has a significant depreciation benefits, such that the effective yield is more like 6%-7.5%, which particularly for a high rate tax payer, is effectively cash flow neutral at interest rates of 7%-7.5%. Assuming you get at least inflationary capital growth, this isn't a bad investment, depending on how much of a deposit you've got wrapped up in the property.

Type 2 is a lowly-geared property. It's easy to get positive gearing if your loan is only say 50% of the value of the property. While this is prudent, there may be a significant opportunity cost tied up in the equity in the house.

I can't see many reasons for a high rate tax payer not to negatively gear - a deduction of 46.5% is certainly significant, given that the capital gain is taxed concessionally at a max of 23.25%. You're not spending $1 to gain 46.5 cents, you're investing 54.5 cents in a property, somehting you can kick, something, the land at least, which will be there when we're all six feet under.

Having said that, if you're going to be completely ungeared, I think a diversified share portfolio is a far better investment than property, especially if you're a 31.5% or lower tax payer.

 

[GoAnna!]

As others have pointed out, negative gearing isn't good unless you're getting a capital gain in excess of the cash cost each year. In fact even if your capital growth, allowing for CGT, is equal to your cash cost, you're still behind as you could have put that cash to an alternative use and got a better return.

I think there are (very broadly) two types of positively geared investments.

Type 1 is the type which yields 5% plus and probably has a significant depreciation benefits, such that the effective yield is more like 6%-7.5%, which particularly for a high rate tax payer, is effectively cash flow neutral at interest rates of 7%-7.5%. Assuming you get at least inflationary capital growth, this isn't a bad investment, depending on how much of a deposit you've got wrapped up in the property.

Type 2 is a lowly-geared property. It's easy to get positive gearing if your loan is only say 50% of the value of the property. While this is prudent, there may be a significant opportunity cost tied up in the equity in the house.

I can't see many reasons for a high rate tax payer not to negatively gear - a deduction of 46.5% is certainly significant, given that the capital gain is taxed concessionally at a max of 23.25%. You're not spending $1 to gain 46.5 cents, you're investing 54.5 cents in a property, somehting you can kick, something, the land at least, which will be there when we're all six feet under.

Having said that, if you're going to be completely ungeared, I think a diversified share portfolio is a far better investment than property, especially if you're a 31.5% or lower tax payer.

I would have thought Type 3 with yields of 10-12% plus positive without tax breaks or depreciation is the true positive gearing? These properties are available at certain times of the cycle.

 

[Peter 14.7]

There are some disadvatages to positive gearing that are minor but worth noting.

You could be postive income but negative capital gain. So you could hold a property say 5 years and overall make a loss. This is likly to occur in a mining town where the property is overvalued when mines runs and worth dirt when the Mine closes. Interesting Rio Tinot has just announced mine closures in WA so this big CG loss could be about to occur.

Gov Family Tax Benefits are calculated on per property loss or gain, not overall like ATO. So if you have say 3 property , one making $10k, and two each losing $5k from the ATO viewppoint, you are neutral. For Family Tax your income is up another $10k. Again if you have say 5 kids this could be significant drop in allowances paid.

This being said being CF+ is the goal.

Peter 14.7

 

[twodogs]

Type 2 is a lowly-geared property. It's easy to get positive gearing if your loan is only say 50% of the value of the property. While this is prudent, there may be a significant opportunity cost tied up in the equity in the house.

This is the part so often not mentioned by promoters of "positive geared" property. Most IP's would be positive geared if you put in a big enough deposit

The only true calculation is to look at the cost of the ENTIRE investment, capital plus purchase costs. No matter where the deposit and purchase costs come from, you are "paying" for that money somehow. Be that interest charged on a LOC, more interest on your home loan as you didn't pay it down, loss of interest from bank savings account or just plain lost opportunity.

If the IP costs $100k plus $5k purchase costs, then the holding costs START with the use of that $105k and no matter how it was gathered, it was supplied either at either a direct cost or loss of other income or more likely both.

If the IP needs a $20k deposit to make it "positive geared", then it is no more "positive geared" than if it had a $50k or $100k deposit. If the rent less outgoings (and any tax benefits) exceeds the cost of the using the $105k then and only then is it "positive geared".

And that does not happen with much less than a 10% + gross yield, ie the $105k propery rents for $210pw as a quick rule of thumb. Perhaps bit less now with lower interest rates.

 

[Perp]

The only true calculation is to look at the cost of the ENTIRE investment, capital plus purchase costs. No matter where the deposit and purchase costs come from, you are "paying" for that money somehow.

Absolutely. You've hit on one of my pet topics! So I've written a blog entry about what positively and negatively geared really mean to me. Even if you all have different definitions, hopefully it will generate some interesting discussion.

 

[Perth Investor]

Two Dogs

You are of course extremely right. The idea of opportunity cost is lost on some people, but it is crucial.

 

[Quasar217]

There are some disadvatages to positive gearing that are minor but worth noting.

Gov Family Tax Benefits are calculated on per property loss or gain, not overall like ATO. So if you have say 3 property , one making $10k, and two each losing $5k from the ATO viewppoint, you are neutral. For Family Tax your income is up another $10k. Again if you have say 5 kids this could be significant drop in allowances paid.

Peter 14.7

Are you sure? I've only ever seen it referred to as adding in "net rental losses" implying it is a net figure across all properties. From next year it will include net share and other investment losses as well, not sure how you could apportion this. In any case, unless the ATO does an audit, how are they privy to that information? All that goes on the tax return is the total rental income and expenses in various categories - it's not itemised per property.