How to Calculate Negative Gearing on Property

Negative gearing is a financial strategy used by property investors where the costs of owning an income-producing asset, such as a rental property, are greater than the income it generates. This situation results in a net financial loss from the property itself. While this might seem counterintuitive, investors often pursue negative gearing with the expectation of long-term capital appreciation of the property’s value. The immediate financial loss can also offer potential tax benefits by reducing an investor’s overall taxable income.

Identifying Rental Income

Accurately identifying all sources of rental income received from the property is important for calculating negative gearing. The most straightforward form of income is the regular rent collected from tenants for their occupancy. This includes payments for both short-term and long-term rental agreements.

Beyond standard rent, other payments can also be considered rental income for tax purposes. Retained security deposits due to tenant damages or a breach of the lease agreement become taxable rental income. Similarly, any insurance payouts received specifically to compensate for a loss of rental income, such as during a period when the property is uninhabitable due to damage, must also be included. Payments received from tenants for services provided, such as utilities if they are not separately metered and billed, also contribute to the total rental income.

Understanding Deductible Expenses

A wide array of expenses associated with owning and operating a rental property can be deducted, reducing the net income or increasing the loss for tax purposes. These deductible expenses generally fall into categories such as ongoing operational costs, borrowing expenses, and costs related to the property’s wear and tear. Interest paid on a mortgage or other loans used to acquire or improve the rental property is typically a significant deductible expense. Property management fees paid to a third party for handling tenant relations, maintenance, and rent collection are also deductible.

Ongoing property-related expenses, such as local property taxes, water and sewer charges, and any land taxes, are deductible. Costs for utilities that the landlord pays, like electricity, gas, or trash collection, can also be deducted if they are not reimbursed by the tenant. Regular repairs and maintenance, such as fixing a leaky faucet, are generally deductible in the year they are incurred, as they keep the property in good operating condition. However, improvements that add significant value or extend the property’s useful life, like adding a new roof, are not immediately deductible but are instead capitalized and depreciated over time.

Insurance premiums covering the rental property against risks like fire, theft, liability, or landlord-specific coverages are deductible expenses. Legal and professional fees for services related to the rental property, such as eviction proceedings, lease agreement preparation, or tax advice, can also be deducted. Depreciation is a non-cash deduction that accounts for the gradual wear and tear or deterioration of the property and its contents over their useful lives. This includes the building and certain assets within it, such as appliances, and is calculated over specific periods determined by tax regulations, typically 27.5 years for residential rental property.

Performing the Negative Gearing Calculation

The calculation of negative gearing involves a straightforward comparison between the total allowable expenses and the total rental income generated by the property over a specific period, typically a tax year. First, all sources of rental income, including rent payments and other tenant-related receipts, are summed to arrive at the total rental income. Next, all eligible deductible expenses, such as mortgage interest, property taxes, insurance, repairs, and depreciation, are added together to determine the total allowable expenses.

Once these two totals are established, the calculation involves subtracting the total rental income from the total allowable expenses. If the total allowable expenses exceed the total rental income, the result is a net rental loss, indicating that the property is negatively geared. This net loss is the amount that can potentially be used to offset other income for tax purposes, depending on specific tax regulations and individual circumstances. Conversely, if rental income surpasses expenses, the property is positively geared, resulting in a net rental profit.

Practical Calculation Example

Consider a hypothetical rental property owned for a full tax year to illustrate the negative gearing calculation. Assume the property generates $24,000 in annual rental income from tenants, representing its sole revenue stream for the year.

Next, itemize the annual expenses associated with the property. Mortgage interest paid totals $15,000, property taxes amount to $3,500, and property management fees are $2,400. Insurance premiums cost $1,200, routine repairs and maintenance are $1,800, and utilities paid by the landlord are $600. Finally, the allowable depreciation for the building and its depreciable assets for the year is $5,000.

To calculate the net position, first sum all the expenses: $15,000 (interest) + $3,500 (property taxes) + $2,400 (management fees) + $1,200 (insurance) + $1,800 (repairs) + $600 (utilities) + $5,000 (depreciation) equals a total of $29,500 in allowable expenses. Subtracting the total rental income of $24,000 from the total expenses of $29,500 yields a net rental loss of $5,500. This $5,500 represents the negatively geared amount for the year, which can be reported for tax purposes.

Maintaining Accurate Records

Maintaining thorough and accurate records is crucial for calculating negative gearing and for tax compliance. Detailed documentation supports all reported income and expense figures, providing verifiable evidence if required by tax authorities. These records should include all rental income statements, such as rent rolls or bank statements showing rent deposits, and any documentation for other income received, like retained security deposits.

For expenses, it is important to keep invoices, receipts, and canceled checks for all expenditures, including property taxes, insurance premiums, repair costs, and utility bills. Loan statements clearly showing the interest paid on the mortgage are also essential. A depreciation schedule, typically prepared by a tax professional, is necessary to substantiate the non-cash depreciation deductions claimed for the property and its assets. Organizing these records systematically, whether digitally or physically, simplifies the annual calculation process and ensures preparedness for any tax inquiries.