There are not many people that can cough up enough money to buy property without getting some kind of loan. Even when you want to buy below market value property (BMV) chances are still high that you will be looking for ways to finance your investment. Today we have a look at what negative gearing actually means in the property investment industry.
The term “Gearing” actually means loaning money with an intention to invest. When you want to buy below market value property chances are high you will use some kind of loan to pay for your property. What makes gearing appealing is the fact that it allows you to invest property of more value than you would normally be able to if you were only to use your savings etc.
When is an investment property negatively geared?
When the costs of maintaining and owning your property and the interest you pay on your loan (note that the repayments of the loan are not taken up in this calculation) together are larger than the income you make with your property (in most cases the rent you receive), we talk about negatively geared investment property. The difference between these costs and the income you receive through this property are considered to be a loss and you can claim this loss as tax deduction, allowing you to pay less tax on your other types of income such as your regular salary.
Proper example of negative gearing
Let’s say for example that you have an annual salary of £100,000, pay £25,000 income tax and are planning to buy a below market value property you’ve seen on the market for £300,000 and have decided to loan this entire amount. You then rent the place out and receive £20,000 annually while you pay £25,000 annually in interest on the loan you took. In addition, you’re facing £2,000 annually in costs related to owning the property you invested in such as insurances etc.
As a result of your investment your annual income would increase to £120,000. You can however claim a tax deduction of £27,000, lowering your taxable income to £93,000. Instead of paying £25,000 income tax you’d now in example pay £23,500, £1,500 less than you normally would.
So negative gearing is a good thing, right?
Not necessarily. In fact, in most cases you’re better off when you can avoid negative gearing, because this would mean that the income you receive from your property investment outweighs your costs related to owning the property investment. Freely translated this would mean that you’re generating profit each year. This while negative gearing means that you are not getting profit each year.Once you’ve paid of the loan you will have a property so even with negative gearing investing in property is a good choice. By looking for below market value property and buying a property that is a financially smart investment you can usually avoid negative gearing. The experts at CTFM would gladly help you make this happen.