Hello, Ben Kingsley here. There's a lot of discussion and debate around property at
the moment and Negative Gearing. So I thought I'd set the record straight in
this series of short videos around What Is It and What Type of Impact that's
going to have on the Marketplace, if there's going to be some changes made to
negative gearing. I want to start with the basics in understanding what it is
and how does it work. So let's take a look. So we've got effectively, money
coming in and that money coming in is what we refer to
as obviously the rent that we get. Let's say we get $20,000 in rent for the
year. Now what's our money going out? Our money going out over here would be
things like holding costs. So we might have the holding costs that are going
out. Let's put those holding costs in and what can these things be? You know,
maintenance and repairs. We've got repairs and we've got, maybe property
management fees as examples. Now let's say as an example, that's $1,000 for the
year. So if we own the property outright, we had $20,000 coming in and we had
$1,000 going out. We would have income of
$19,000. Now that $19,000 is added to our income tax for that year and we pay tax
on that income. So we are going to pay tax. Now that's NOT negative gearing.
That's just a property that doesn't have any other costs associated with it but
what if we introduced some other costs? So what are the costs are there and this
is where the gearing comes in. So understanding the concept of gearing...
we're going to use that word. Gearing is effectively mean that we borrow the
money. We're going to borrow to invest and in this particular case, we borrow a
bit of money and the interest costs... So the interest on the costs of that. Let's
say that was also $20,000 for the year. Now we've got those borrowing cost, the other
type of costs that we might also be able to write down or write off is a
thing called depreciation. Now depreciation works in terms of the
fixtures and fittings and the building itself, is going to deteriorate over time.
So we're able to write those off. It's not actually a physical cost that we
have to pay but it helps in terms of being able to claim that cost against
your income for that year. So let's say in this particular case we had $5,000.
Now that would mean if we got the $1,000, the $20,000
and $5,000, then we had $26,000
in claimable costs. Okay. So that would mean if we had $20,000
coming in for rent and $26,000 going out. We would be
operating that property at a loss for that year. That loss would simply be
$6,000. Now this is the negative gearing piece. So we've got the
gearing coming in here, the property is running at a loss and we've made this
$6,000 loss. Now we were able to offset that $6,000
against our PAYG income or our pay-as-you-go withholding income. So the
marginal tax rate that we're on now... Different people are on different
marginal tax rates and that will be affected. So let's say hypothetically,
that marginal tax rate is 50%, the highest you can possibly get
for ease sake. And now that would mean that there's $3,000 that
we would be able to claim back but there's still $3,000
that we've completely lost. So if anyone's thinking about investing in
property and continuing to run at a loss, well they've got rocks in their head.
Because that's not good management. That's not good investing. What we need
to understand is that negative gearing is only a moment in time and you can
understand that the interest cost would be adjustable by how much you borrow.
If you borrow more, you might have higher interest costs early but if you borrow
less that interest cost could be low which I demonstrated in the first
example where we had no interest cost at all. The property was positively
delivering income. We have to pay tax on that income. So
what you then understand is if we were to draw a diagram of time and value, we
would start to see over the years... So we go time here in years and then we look
at a midpoint which is our break-even point. That's zero dollars and we
might have -$5k, -$10k and up here we have $5k and I'm going
to keep it going because it's really important to understand this. We've got
$10k, $15k etc. You might start off where you are in negative territory
and then you move through as you pay down that debt, the rent goes up.
Inflation plays a role in that. So if we think about our break-even point
and you're still going on over time, we have a period where we are in
negative. Running the property a loss which would mean
we'd be able to have some tax refunded to us. So there's a tax refund here in
terms of offsetting other income or tax that we've paid. When it
passes that line and goes to neutral or positive, it means we have tax payable.
And this is what a lot of people don't understand or are missing the
point. You don't invest in property to run it at a loss. You invest
in property to make a gain over time. The tax refund that you're getting early
helps you from a cash flow point of view and it helps the typical mum and dad
from investing. High-income earners in some cases can run properties
at losses so it's not going to stop the high-income earners from continuing with
this strategy but if you were to ban negative gearing for mum and dad
investors, then ultimately you're going to have a series of consequences. Both
intended and unintended associated with that. Which means less investment and
also means less rental accommodation available. And ultimately, this means higher
rents. But I'll explain that in one of the upcoming videos. So I want to close
off. This is what negative gearing is with the final point around the taxation story.
When we think about tax, there's a couple of taxes that we pay.
So we get a tax refund when we experience a loss for
that year but what tax are we paying? What tax do property investors pay? In
terms of what's tax payable, well there's quite a bit. I'm going to try and
squeeze them all in here but obviously from a state level, we have stamp duty.
Now stamp duty is a one-off, so we pay that as a one-off cost but
when you own investment properties, you also pay land tax and that land tax is every
year. Then from a Federal point of view, we also have other costs in taxes
that we have to pay such as, it's part of our income tax. So once it becomes
positive, we pay income tax. And then if we sell that property, we pay a lot of
capital gains tax. So you've got capital gains tax as well as the income tax that
you will be have to pay each year. So it's really important to understand that
a property investor adds a significant amount of taxation revenue at both the
State and Federal level. The negative gearing
portion of that time is only early and then over that time period, it becomes
positively geared. Now you might say people are just speculating in property.
We disagree with that. You invest in property for the long term, you don't
invest for two or three years. That's too expensive to do and as we seen
at the moment, property prices don't always go up. So the longer you hold that
property, the better position you're going to be in. That's the concept of
gearing. So adding gearing which is really the biggest cost you have in
terms of the interest that you're paying. If interest rates are lower,
that cost basis is lower. Some properties can also move to positively geared
earlier if that interest cost is lower. So it's important to understand there's
quite a few moving parts to this but the fundamentals are this. You invest in
property for LONG TERM passive income to supplement your superannuation and your
retirement income. And that will mean that you'll be less of a burden on both the
State and Federal Governments because if you can self-fund your own retirement,
then you're in a greater position to enjoy life. But also be less of a burden
on the tax person. Thanks for watching.