Positive Or Negative Gear??

[Happydays]

Positive Or Negative Gear

Hello New to the property investment market.
Looking to buy my first IP and plan to buy a few more over the next few years..

I have a healthy income where i pay alot of tax..
I have always heard i should Negatively gear a loan..
But keep reading a lot on here about people Positively gearing theirs..

Im trying to keep my tax down. is there any reason why i would be wanting to positively gear my loan??

 

[Aaron_C]

Because positive gearing means more money in your pocket than out...

 

[Happydays]

Because positive gearing means more money in your pocket than out...

And more tax that i have to pay..

Looking for abit more detail if possible.. Or it is this simply.
Positive gearing = more many and more tax
Negative gearing = Less money and less tax

then why do people Negatively gear??

 

[Aaron_C]

And more tax that i have to pay..

Looking for abit more detail if possible.. Or it is this simply.
Positive gearing = more many and more tax
Negative gearing = Less money and less tax

then why do people Negatively gear??

In a nutshell, that is true.

The reason why people negative gear is because they are hoping that the future capital gain from the property purchase exceeds the tax losses from the negative gearing.

For example, if you buy an investment property and are losing $20,000 each year due to interest, you expect that your capital gain on the property would far exceed $20,000 per year.

It allows you to reduce your tax every year, while building your asset values and not paying tax on those gains since you haven't sold the property.

 

[skater]

is there any reason why i would be wanting to positively gear my loan??

Um....how about making a profit?

To negatively gear a property means that you are making a loss on it. If you are on the top rate of tax, that means that for every $1 you lose, the government will let you declare it as a loss, meaning that you save, around half of that loss. BUT it still means that you have lost money.

Of course, most people buy with the expectation that they may make a capital gain. But, what happens if you bought a dud? Or at the wrong part of the cycle? Or you have to sell before you planned? Or any one of many reasons why you might sell and NOT make a gain in that property.

 

[Indifference]

Im trying to keep my tax down. is there any reason why i would be wanting to positively gear my loan??

surely you jest.

Agree with Skater, but also add:

Are you investing to make money? Eventually, your portfolio should be returning a PROFIT (ie. cashflow positive for property) so you can CHOOSE to keep or discard your J.O.B.

Why else do you invest? is it just to try and sidestep the taxman?

 

[Peter_Tersteeg]

Let's take a look at negative gearing vs positive gearing in the current market. I'll take a reletively narrow view assuming you're not doing any other investing and that you're on a very high salary in the top tax bracket.

Negative gearing gives you a tax break. The reason is because the cost of owning the asset is greater than the income produced by the asset. If your investment property costs you a dollar to hold (after costs and income), you'll get 0.45 cents back in your tax return. It still costs you 0.55 cents to own the property.

The reason people negatively gear is because the believe the property will increase in value. Whilst this is generally true, it's not always the case. Certain areas in Melbourne at the moment have been dropping in value for some time and are likely to continue to drop in value for a while longer.

If the property is dropping in value, and you're negatively geared, please explain why you'd deliberately loose $1 to get 0.45 cents from the government?

If you're negative gearing because you believe property prices will turn around in the long term, you'll get good capital growth and this will outweight the holding costs, that's reasonable. Negatively gearing for the purpose of paying less tax is a bad view to take. Personally I don't even consider the tax effects when evaluating an investment purchase unless it's going to be cashflow positive and I'll get an additional tax benefit.


Conversely positive gearing means you may pay some tax. You make $1. You pay 0.45 cents tax. You're still 0.55 cents in profit. In this case it doesn't matter what the value of the property does if you never sell it, you're still making money.


These outcomes could be very different depending on a larger investment strategy. It does hold true if you're looking at a single investment property on its own as a buy and hold. Stating that you, "want to buy property so you'll pay less tax," isn't a good thought process and suggest you need to learn more about investing and what paying tax really means.

 

[skater]

Because positive gearing means more money in your pocket than out...

And more tax that i have to pay..

Yes, but you don't go broke making a profit, do you?

 

[Happydays]

surely you jest.

Agree with Skater, but also add:

Are you investing to make money? Eventually, your portfolio should be returning a PROFIT (ie. cashflow positive for property) so you can CHOOSE to keep or discard your J.O.B.

Why else do you invest? is it just to try and sidestep the taxman?

Well i am looking for my first IP, I am in my mid 20's. my plan over the next decade is to pay less tax. But obviously in the long term i would like to retire on my IP's.

I am already in the highest tax bracket so any tax offset i believe is a bonus. But i am still new to all this so wanting to hear anybody's input.
Thanks..

 

[alexlee]

Well i am looking for my first IP, I am in my mid 20's. my plan over the next decade is to pay less tax. But obviously in the long term i would like to retire on my IP's.

Pay me $10. Deduct it and you get to pay less tax. So, with your objective of paying less tax, pay me everything you earn. Then you pay no tax. Make sense?

 

[Peter_Tersteeg]

Well i am looking for my first IP, I am in my mid 20's. my plan over the next decade is to pay less tax. But obviously in the long term i would like to retire on my IP's.

I am already in the highest tax bracket so any tax offset i believe is a bonus. But i am still new to all this so wanting to hear anybody's input.
Thanks..

As every post here as already stated, stop thinking about tax. Look at a property and ask yourself, "How will this property make me money?"

If you don't make money from the investment in the first place, tax deductions isn't going to make it profitable.

Making money from your investments is what counts. Everything else is just something you have to do to make the money, or it's a bonus.

 

[TonyY]

can we give my situation as an example? I have a property that I live in soon to rent out. Northern suburbs of Melbourne, capital growth is promising. Knowing that there will be capital gain in the next two years, I alone earn 3.5k p/m net and pay $1900 IO. The loan i took out is 319k. I've had it for two years now just paying IO... Do I negative gear or positive gear? I'm also very, very new at investment.

 

[Happydays]

Thanks PT Bear.
This is a good help..
I am not buying a property for a tax offset, buy my idea was that would be one of the bonus's involved..

I am planing to buy hoping for property rise to make money in the long run more so then to make profit of the property now.

Again i am very new to all this.
Not to sure if it works this way, But buy taking a 15 year loan instead of a 25 year loan making my loan repayment higher a way to negatively gear??
So this way i am paying the loan quicker without needing to pay tax on any profits. Not talking about massive negative gearing but enough not to be paying tax on this money that could be instead going towards the loan.. so instead of 50 cents in my pocket I'm getting $1 towards my loan.

Then is 10/15 years the property can turn into a positively geared investment..

Again i am very new to this. But is this a smart or stupid idea??? Or is Negatively gearing even able to work this way..

 

[Peter_Tersteeg]

can we give my situation as an example? I have a property that I live in soon to rent out. Northern suburbs of Melbourne, capital growth is promising. Knowing that there will be capital gain in the next two years, I alone earn 3.5k p/m net and pay $1900 IO. The loan i took out is 319k. I've had it for two years now just paying IO... Do I negative gear or positive gear? I'm also very, very new at investment.

Tony you've stated that your stategy to make money from this property is via the capital growth. If you've borrowed most of the property value you will be negative geared to some degree and based on your income the goverment will only help you out 30 cents in the dollar on your losses.

This is all fine as long as your expectation of capital growth is realised. If the value doesn't increase, then you're just throwing money away. (Personally I think you'll be fine over the long term).

If you've got a huge amount of unused cash, you could reduce the loan to the point where the property is positive geared. If this is the case you should also assess if there's something else you can do with that cash which might put it to better use. If there isn't a better use that you're comfortable with, then I'd suggest that you do positive gear the property (and stop loosing 70 cents in the dollar, instead you'd be paying 30 cents tax for each dollar profit you make).

If you don't have enough surplus cash and you need to borrow most of the property value, then you don't have the luxury of choosing to be postive or negative geared. You'll just need to have faith that your capital growth prediction will occur.

 

[Peter_Tersteeg]

TBut buy taking a 15 year loan instead of a 25 year loan making my loan repayment higher a way to negatively gear??
So this way i am paying the loan quicker without needing to pay tax on any profits. Not talking about massive negative gearing but enough not to be paying tax on this money that could be instead going towards the loan.. so instead of 50 cents in my pocket I'm getting $1 towards my loan.

You can only claim the interest as a cost so paying the loan off in 15 years will not immediately give you any change in how positive or negative geared the property is.

Additionally as you're paying down the principal faster, the interest component of your repayments will reduce faster so the negative gearing benefits will also reduce.

You also need to determine what the opportunity costs of the higher repayments are. Could you take lower repayments and put the money to better use?

I'd suggest a better strategy would be to go with a 30 year loan that's interest only for at least 5 years. Your mandatory repayments will be as small as possible. The benefits are:
1. You'll have more surplus cash and you can also add to paying off the loan, or you can put it to other use at your discression.
2. If you decide to maximise your tax deductions, making the minimum payments is the way to accomidate this.

Essentially this strategy gives you options. A 15 year principal and insterest loan commits you to a high mandatory repayment. An interest only loan has a lower mandatory repayment. You can still make additional volantary repayments if you wish (I'd do this via an offset account, but I'll save that for a different discussion).

A good reason why you might want this flexibility could be that you later decide to buy your own home. At that point you would divert all your surplus cash to paying down the non deductable home loan and only make the minimum repayments on the tax deductable investment loan.

Another example would be if you loose your job or get a pay cut. In this case it might be handy stop the extra repayments instead of being committed to the higher mandatory repayments of a 15 year term.

 

[Happydays]

You can only claim the interest as a cost so paying the loan off in 15 years will not immediately give you any change in how positive or negative geared the property is.

Additionally as you're paying down the principal faster, the interest component of your repayments will reduce faster so the negative gearing benefits will also reduce.

You also need to determine what the opportunity costs of the higher repayments are. Could you take lower repayments and put the money to better use?

I'd suggest a better strategy would be to go with a 30 year loan that's interest only for at least 5 years. Your mandatory repayments will be as small as possible. The benefits are:
1. You'll have more surplus cash and you can also add to paying off the loan, or you can put it to other use at your discression.
2. If you decide to maximise your tax deductions, making the minimum payments is the way to accomidate this.

Essentially this strategy gives you options. A 15 year principal and insterest loan commits you to a high mandatory repayment. An interest only loan has a lower mandatory repayment. You can still make additional volantary repayments if you wish (I'd do this via an offset account, but I'll save that for a different discussion).

A good reason why you might want this flexibility could be that you later decide to buy your own home. At that point you would divert all your surplus cash to paying down the non deductable home loan and only make the minimum repayments on the tax deductable investment loan.

Another example would be if you loose your job or get a pay cut. In this case it might be handy stop the extra repayments instead of being committed to the higher mandatory repayments of a 15 year term.

Thank you again PT Bear..
This is all starting to make more sense.. Question.. If i take a 30 year loan with 5 year interest free.. Is the idea never to own this property?? just to make money off it and hope it increases in value??

This giving you more money to put towards a large amount of investment properties. for example over the next 20 years invest in a dozen properties. then when it comes time to retire sell 8 of them with the hope this gives you enough money to pay off the other 4.
Happily retiring with 1 property to live in and 3 to live off..

Am i on the ball park??

 

[skater]

Thank you again PT Bear..
This is all starting to make more sense.. Question.. If i take a 30 year loan with 5 year interest free.. Is the idea never to own this property?? just to make money off it and hope it increases in value??

Not interest free! Interest only! This means the initial loan amount stays the same.
It also gives you control over where you put your money. You might have a mortgage on a PPOR, which is not tax-deductable. You might prefer to pay that off before the tax-deductable mortgages are paid off. It could also mean that you are putting excess funds in an offset account, which gives you a lot more flexibility than putting it straight into your loan.

This giving you more money to put towards a large amount of investment properties. for example over the next 20 years invest in a dozen properties. then when it comes time to retire sell 8 of them with the hope this gives you enough money to pay off the other 4.
Happily retiring with 1 property to live in and 3 to live off..

Am i on the ball park??

Yep! Getting closer. That is a strategy that plenty of investors use. It's not the only one, but it is one that works.

 

[wobbycarly]

Thank you again PT Bear..
This is all starting to make more sense.. Question.. If i take a 30 year loan with 5 year interest free.. Is the idea never to own this property?? just to make money off it and hope it increases in value??

This giving you more money to put towards a large amount of investment properties. for example over the next 20 years invest in a dozen properties. then when it comes time to retire sell 8 of them with the hope this gives you enough money to pay off the other 4.
Happily retiring with 1 property to live in and 3 to live off..

Am i on the ball park??

Peter's given you lots of ideas. Now you have the option of either a) doing additional research on your own or b) engaging him as your broker.

Option b) will give Peter the opportunity to further educate you, as well as help you develop and appropriate financial structure to allow you to achieve your financial goals.

I personally don't use Peter, but I do as many others on here would also, use a broker to help me talk through various scenarios and then use them to obtain my finance (the latter for which, of course, they get paid.)

Just a suggestion so you can get more personally targeted advice.

 

[Gools]

HAppyDays, just a couple of things. If you don't have anywhere to park your excess cash then make sure you get an Offset Account with your IP mortgage. Put any excess money in there and when the time comes and you buy PPOR (your own home) you can pull the money from the Offset Account and use it for the purchase.

Imagine what your tax bill will be like in 20 years time when you sell your four houses. Then you'll have a huge tax bill but no worries. Don't be scared to pay tax. It's a good indicator that you are making money. In a dodgy economic period it could well be a good thing.

The other thing not really mentioned yet is the increasing rents. Most negatively geared property will become positive over time. Then your tax 'problem' will be back again.

Gools

 

[bbmick]

I've always felt that negative gearing restricts your loan servicibility and can quickly become an anchor, holding you back from your potential of having a massive portfolio.

For me, positive or neutral is the the way to go. But that's probably due to the fact we're already in a low tax bracket and have little tax to claim against and suits my goals better. That is, not being a slave to an employer and having a good nights sleep.