Negative Gearing…. the part that wasnt mentioned

From the sounds of it you Mum is under the impression that with an interest only IP loan her overall cash flow is positive. This is then placed back into her PPOR to pay it off sooner along with the regular mortgage repayments.

If a property is Cash flow negative or Negatively geared by the very definition it is earning less than it is producing so there would be no cash benefit for the PPOR.

Negative gearing was a hot trend about 5 years ago, but is now generally looked down on.

In theory, as I understand it:

PPOR is on P&I loan, and Mum wants to pay off debt as fast as possible because all costs are straight out of pocket (and with after tax dollars at that).

IP is on an interest only loan, which is tax deductible. Mum pays minimum repayment each month (channeling all spare funds into her PPOR).

If Mum is earning a reasonable income from her normal day job, then come tax time she can claim her IP losses (including depreciation) to reduce her taxable income and gain a good tax return.

Say it costs mum $40 per week out of pocket to service her IP ($2,080 p.a.) but she can deduct *all* expenses to do with the property, including management fees, interest rate, depreciation, etc from her total income. She may find herself with a tax refund of considerably more (say $6,000 p.a.) come tax time – which is more money than she personally put in over the year.

Mum puts tax return monies into her PPOR to lower her P&I loan. $6,000 is better than $2,000.

If mum had instead split her disposable income equally between her PPOR and IP, she would have gained a smaller tax return. PPOR is never going to offer tax benefits, while IP does, so it makes sense to pay off PPOR before IP.

This is successful negative gearing – providing a)that you have a good enough day-job income to make full use of tax benefits and b) you are using tax benefits to pay off ‘bad’ debt.

It’s a bonus if your IP also increases in capital value – though many investors would argue that this is not ‘negative’ gearing if the property value is gaining ‘positive’ growth. This could be why you are confused about your mother’s situation if hers is a case of +cg, while others are talking about zero cg and negative cf.

So: when people say ‘negative gearing’ they could mean one of several things. It is indeed confusing.

The term ‘negative gearing’ became misused by property developers trying to sell property to green investors. They pointed out tax benefits, listing it as an income source unto itself – and ignored the fact that many of these investors were not in a position to hold onto a hugely cf- property as they waited till tax time, nor did all of them have an income large enough to take full advantage of tax benefits. Negative cashflow often outweighed the true value of tax benefits.

And if they weren’t then using the tax return to pay off a PPOR or ‘bad debt’ then the whole exercise was wasted. You have to pay the money out before you get more back – and what is the point in holding a property that is cf- and has little to no capital growth?

These same developers often also factored in ‘projected capital growth’ to the schedules to make it seem like an amazing opportunity in an attempt to flog overpriced units. They also tended to leave expenses (stamp duty, land tax, etc) out of the equation, and gave 12 month ‘rental gaurentees’ far above market price so the investor was in trouble once they hit the second year.

The ideal is to be positively geared both by cg and cash flow (making money is always good, even if it means paying more tax) – but this is often unrealistic. You generally have to pick whether cf or cg is more important to you, and choose properties that met that strategy.

A property that only ever costs you money is a dud, which is why most people sneer at negative gearing. But if it works for your mum (I take it she has fully investigated the finanial viability of her set up, and found that it does benefit her financially) then enough said.