Negative gearing challenged

USING negative gearing as an objective to invest in property is not advisable according to Nick Renton in his book Understanding Investment Property.

“Investment in real estate should be viewed as a long term proposition, useful in its own right rather than as a means of avoiding income tax through devices such as negative gearing,” Mr Renton writes.

“Some people are so concerned with minimising income tax that they fail to focus on what should really be one of the prime investment objectives, namely, the maximising of ‘after tax’ income.

“After all, $1000 gross less $500 tax is better than $400 tax-free.

“Similar remarks apply also in the case of people who concentrate unduly on maximising their social security benefits rather than on bettering their total position.

“Some persons are so keen to get a few hundred free dollars from the government that they are willing to forgo a few thousand earned dollars in potential investment returns.

“They also overlook the fact that increasing one’s periodical investment income usually also results in increasing one’s total wealth.

Mr Renton describes gearing as a two-edged sword – it magnifies gains when assets go up in value, but also magnifies losses.

Gearing relates to the net return of a property investment, he explains.

The net return will be the rent received less the direct expenses borne by the owner and the applicable interest.

If these expenses and interest exceed the rent then the net return is negative and the property is said to be “negatively geared”.

“If the property is negatively geared then the excess of the deductions over the assessable rent can be used to reduce the tax otherwise payable in respect in respect of earnings from other transactions.

“Some persons deliberately seek out negatively geared investments.

“They often overlook the fundamental fact that the primary aim of investment should be to maximise ‘after tax’ income, rather then to minimise tax.

“If the aim really were to get negative gearing as a objective in its own right then all an investor with a positively geared property would have to do would be to ask his tenant to please pay him less rent or ask his lender to please charge him more interest.

“That would clearly be nonsense,” Mr Renton writes.

“Negative gearing can be justified where the investor expects that the rent will increase sufficiently in later years to compensate for the unsatisfactory initial position or that there will be appropriate capital growth.

“The real aim should always be to increase an investor’s total wealth, not simply to send less tax to the government,” he writes.

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