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Negative gearing alert: The first rule of investing is to make a profit

Mar 03, 2016

The bottom line with negative gearing is that your investment is making a loss, and those banking on windfalls down the track are playing a risky game, writes Andrew Robertson.If tax breaks are a primary reason for making an investment you are at the mercy of our politicians.

And so the debate about negative gearing is heating up. Labor wants to rein it in and the Government is warning that will send house prices crashing.

But amidst the huffing and puffing in Canberra, one thing seems to be ignored. The first rule of investing is to make a profit on the investment. Tax breaks are secondary.

The bottom line with negative gearing is that your investment is making a loss. The income (rent) is not covering interest costs or the expenses of running the property.

Those losses are deductible against your income and you are looking to your tax return to cover as much of the gap as possible.

Of course, the tax deduction is bigger for those on higher marginal tax rates, so the overwhelming benefit from negative gearing goes to those on high incomes.

In a former life, Deakin University senior lecturer in financial planning, Dr Adrian Raftery was known as "Mr Taxman" and he's written many books on the subject.

He says people need to see negative gearing for what it really is.

"For example, you spend $10,000 and get back a maximum of $4900 back. It means that your bank account is $5100 worse off by going into the transaction (it gets worse for those on the 19 per cent tax bracket, the net outlay is $8100). That's negative gearing for you in a nutshell."

Sydney-based financial adviser, Suzanne Haddan, from BFG Financial Services, says, "it never ceases to amaze me when people congratulate me on their tax cheque."

"Tax cannot save poor investing."

Those who negatively gear are betting on a big capital gain when they sell the property to more than make up for the losses on the income side.

It's a dangerous strategy where the risks have been masked in an environment where, up till the last six months or so, house prices have been rising strongly.

"The only upside is that you are reliant on the property increasing in capital growth by an amount greater than your outlay - but remember to factor in capital gains tax and what you could have received if you simply had your money in the bank on term deposit," Dr Raftery said.

And he goes further: "If a property market is stagnant, like we are experiencing in Australia with the growth years now behind us, then you will be falling behind. If the property market falls to levels like it has around the world in the past decade (30-50 per cent), then you are in a dire situation."

The other big risk with negative gearing is legislative risk.

If tax breaks are a primary reason for making an investment you are at the mercy of our politicians - one parliamentary vote away from financial disaster.

As we've already noted, if Labor wins the next election it's pledged to start winding back negative gearing for housing. Which means under Labor, if your investment property is not making a profit, you may lose your tax deduction as well.

In other words, you will be wearing all your losses.

Ms Haddan says people get caught up in the excitement of negative gearing and, like Dr Raftery, she thinks they ignore other investments which may be more beneficial.

"For many people, salary sacrificing more into superannuation will often beat negative gearing," she said.

For those considering negative gearing, Ms Haddan gives this advice: "There's a lot worse things in life than making a profit."

Sadly, she says the queues are often longest where the profits are lowest.

Andrew Robertson is the chief reporter for ABC's The Business.

Original article published here on ABC - The Drum on 4 March 2016.

Tags: 101 WaysAccountant SydneyDeductionsPersonal tax

Author: Andrew Robertson

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