In order to encourage the investors to invest in real estate, the ATO introduced negative gearing as a method of personal rental, which generates taxable income (Assessable Income). This taxation change usually arises when there is a ‘net rental loss’ in your investment.
This method of negative tax reflects the principle within accounting called “Accrual Accounting”. Accrual accounting refers to the recognising of economic events regardless of when cash transactions occur. The general idea is that economic events are recognised by matching revenues to expenses at the time in which the transaction occurs rather than when the payment is made (or received). This method allows the current cash inflows/outflows to be combined with future expected cash inflow/outflows to give a more accurate picture of the investment.
By applying this principle, rather than receiving straight cash income or revenue, you may use your investment into a property to reduce tax. Although your investment will appear on the book to be depreciation, this is not the fcase when everything is calculated.
Your salary for this year is $80,000 and after tax you are left with $62,453.
This is calculated as followed: Tax: ($80,000 – $37,001) x 32.5% – ($37,000 – $18,201) x 19% = $17,547
Suppose last year you purchased a new home worth $600,000. 80% of the cost would be attributed to loans granted by the bank, with a loan interest rate of 5.5%. Depreciation of the house in the first year is $18,000.
Take into account the other expenses, which may include:
- Municipal fee (council fee)
- Water (Water fee)
- Property management fees (Strata)
- Loan interest (mortgage interest)
The income that you would receive would arise from the rent, and rental rates in return (ROI) would be 5.2%.
Therefore, your income would be calculated as below:
Income – expenses = $600 x 52 (one year’s rent) – 5.5% x $480,000 (interest on loans) – $500 (water) – $1200 (property fee) – $600 (municipal fees)
This may appear negative, as you receive nearly no income from the property (as the house is depreciating by $18,000 a year). This is where negative gearing works towards the investor’s advantage. If we recalculate the amount of tax this year:
Investment losses are included in the year’s taxable income.
$80,000 – $18,000 = $62,000
Tax = ($62,000 – $37,001) x 32.5% – ($37,000 – $18,201) x 19% = $11,697
It can be seen therefore that you can receive more money from the ATO through taxes.
($17,547 – $11,697) = $5850