When the costs linked to an investment surpass the revenue it generates within a year, negative gearing permits the owner of the asset to claim a tax deduction against their other sources of income. Before getting into the reasons why negative gearing might not be the smartest investment strategy, let’s first get a grip on what negative gearing is and how it operates.
1. Negative Gearing is NOT a Strategy; It’s a Tax Outcome
Many investors mistakenly view negative gearing as a strategic approach to wealth accumulation. However, it’s important to understand that negative gearing is a result of the financial dynamics of a property, not a deliberate strategy.
Consider a scenario where an investor, John, owns a rental property generating $20,000 in gross annual rental income. However, the costs associated with the property, including mortgage, insurance, and property management, amount to $25,000. John faces a $5,000 loss, which can be offset against his income from a job or business for tax purposes. While this may seem like a tax advantage, it’s essential to question whether the overall financial outcome aligns with John’s investment goals.
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2. Lack of Cash Flow
Opting for a negatively geared property can have real-life consequences on your daily lifestyle and spending capabilities.
Consider two individuals, Sarah and Mike. Sarah owns a negatively geared property, incurring an annual loss that limits her discretionary spending. On the other hand, Mike, who has chosen not to invest in property, enjoys a more comfortable lifestyle without the financial constraints imposed by a negatively geared investment.
3. Capital Losses
Investing in a property that continually experiences losses, even after accounting for tax benefits, can be counterproductive to your wealth-building goals.
Imagine purchasing a property for $500,000, incurring annual costs of $25,000, resulting in a persistent loss. Over a five-year period, despite claiming tax deductions, the property’s value hasn’t appreciated, and you are left with a significant capital loss.
Check out “How Can a Negatively Geared Investment Property Work to Your Advantage?“
4. Limited Serviceability
If building a robust property portfolio is your goal, investing in negatively geared properties might obstruct your progress.
Emily aspires to build a diverse portfolio, but her current investments are all negatively geared. When approaching banks for additional loans, they express concern about her serviceability, given the ongoing losses from her properties. As a result, Emily finds her borrowing capacity restricted, impeding her ability to acquire more properties.
5. Trapped in the Rat Race
The irony of investing in negatively geared properties is that it can intensify your dependence on employment to service the associated debts.
James, who initially aimed to achieve financial independence through real estate, finds himself more reliant on his job to cover the losses incurred by his negatively geared properties. The dream of escaping the rat race becomes elusive as job security becomes paramount.
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6. You Don’t Need to Negatively Gear to Grow
Contrary to common belief, there are viable alternatives to negative gearing that allow for positive cash flow and substantial growth.
Consider investors who chose positively geared properties in regions like Geelong, Ballarat, or Bendigo. Over the years, these investments not only provided positive cash flow but also witnessed substantial growth, outperforming properties in major cities.
In conclusion, these examples and scenarios underscore the potential downsides of negative gearing. While the tax benefits may seem attractive, it’s essential to evaluate whether the overall financial outcome aligns with your long-term investment goals. Exploring alternatives that offer positive cash flow and growth can pave the way for a more sustainable and prosperous investment journey. Remember, real estate investment is not one-size-fits-all, and understanding the nuances of different strategies is key to making informed decisions on your wealth-building journey.
