With Kyle Thompson | Senior Adviser
Towards the end of each financial year, we often find ourselves discussing the merits of negative gearing with our clients based on the common belief that this loss can be used as a direct tax write-off. Unfortunately, what many fail to consider is that the tax refund doesn’t cover your total loss. For the self-employed, these questions arise all too often immediately after their latest PAYG instalment.
The bulk of negative gearing occurs where people have borrowed to buy an investment, be it a house or shares, and the interest cost of that borrowing exceeds the income from the asset. This loss can then be written off against that individual’s normal income. So it is true that it can help to reduce someone’s tax bill, but don’t forget from a cash flow perspective, the person has still lost money on their investment in the short-term. For Example, if their loss for the year is $10,000, they don’t get the full $10,000 back from the tax office. Even if that individual is on the top tax rate, they’ll only get back $4,900 and will, therefore, have to cover a loss of $5,100 from their own cash flows.
As such, individuals entering into such arrangements need to be certain that the asset they’re borrowing to acquire will generate sufficient capital growth to offset these losses over the long term. This is an important point and must be considered in relation to your overall investment strategy. Although these strategies often form the basis of a sound investment plan, entering into any investment solely for the purpose of obtaining a tax deduction is fraught with risk and must be considered with great care. If this is a strategy you are considering, seek advice first and get in touch with your Adviser today.