There is a very old and worn out chestnut of a saying, a staple of investment spruikers and a notion that is deeply embedded into the psyche of the Australian investor – ‘you can’t lose money investing in property’ This concept seems so ingrained and sacrosanct that I am surprised, Watson and Crick didn’t include a ‘strand’ named “property investment” into their double helix.

I am going to begin this post by declaring that I am not at all in favor of buying a property for in- vestment purposes. Considering this is probably the most common way most people invest, particularly in Australia at least, you can see that I am certainly at odds with the vast majority.

But it’s only investment properties I am against and certainly not an owner/occupied dwelling. There is a great deal of difference between buying a suitable home for your family and purchasing an asset for wealth creation.

Usually, the majority of investors will borrow money to purchase their investment property, so let’s start with this aspect. The term often bandied around is to ‘negative gear’ – a literal translation being to ‘borrow money for the purpose of making a loss” No doubt this would have to be only in- vestment strategy that actually commences, with the intention of losing money! A rather auspicious start I would have thought – not!

‘But, I get a tax deduction for my losses’, is the immediate retort – and yes you do. And that’s very kind of the tax department I say! But take a closer look. The average tax rate in Australia is about 30%. Remember we have a sliding tax rate so this figure is an average ‘ballpark’ figure. (If you like, you can use any tax rate as an alternative for the examples I discuss.)

Using the 0.30c means you’re refunded 0.30c cents for every $1.00 you spend towards your investment property. Which is predominantly the difference between your rental income and your mort- gage repayments. Should the expenses exceed the income, the amount not covered by the income is the tax-deductible amount.

Now, think about how you pay tax. Firstly, for every dollar you earn, you lose 0.30 cents to the tax man (using the average rate). In other words, each income dollar is divided into two parts, 70 cents for you and 0.30 cents for the tax office. Okay, easy so far, so let’s now look at the deduction calculation; expenditure above the rental income is said to be fully tax deductible.

But the process of creating a tax refund at the end of the financial year actually requires reducing your income- yes you heard right, reducing your income! If you can do this, then the taxation department will return the tax they deducted from your pay. Hence to enable you to reduce your tax you must first be able to reduce your income.

Because you have a property that has greater outgoings than in-goings (making a loss in other words) you are entitled to reduce your income by the amount of that loss. Now every “loss ” dollar having qualified as a legitimate expense, can be deducted from your income and it is these funds that are referred to as fully taxing deductible.

Therefore, each out of pocket dollar spent will reduce your income and because you have already paid the tax of 0.30 cents on that income, you are entitled to get that back. (I hope you are still with me!)

In simple terms, you actually spent one dollar to get 0.30 cents back!  Mmmmm- not one of the worlds great deals I should say.

Therefore the amount you spend above the income you receive from the property is costing you directly 0.70 cents in the dollar. You now need to recover that deficit via your capital gain when you sell before declaring you have made a profit. Are you keeping count?

And yes, there certainly are many other tax deductibles ‘bits’ like depreciation etc. but generally I think the equation of 0.30c in every dollar is a vivid metric to illustrate the process of negative gearing.

But wait, there is a bit more. There is a ceiling on the amount of tax refunded – the losses you make are offset against your other income, usually your day job. That income is taxed at the source before you receive it, with the total tax tabulated at year end on your group certificate. That total figure of tax is the maximum refund you can get, presuming you have sufficient deductions of course).

You cannot get back the tax you haven’t paid. So no matter how many fully tax-deductible dollars you spend, if you run out of income tax paid, there are no further deductions. Go on, you do the

math, as our American friends would say!

Remember, all the expenditure that has not been covered by a tax refund needs to be recouped through capital gains before you can shout “I made a profit”. And you haven’t even touched on the costs of upkeep and repair, possible damage from recalcitrant tenants, lack of tenants, land tax, conveyancing fees, stamp duty etc. Are you starting to get the picture?

There are a lot of outgoing expenses that really need to be tabulated before you decide on signing up. Oh, while we are at it, let’s also throw in purchasing at the wrong time in the cycle or in the wrong geographic region – wooo hoooo what a ride!

But hang on you are saying, the bank certainly wouldn’t approve a loan if they thought it was a bad deal! Absolutely correct; they don’t want to make a loss, and will always have their interests top of mind. So that’s why they take security over the investment property and your home, in the major- ity of cases. Their idea of a good deal is to give themselves two properties to protect themselves from loss – do you see what they are telling you?

When people refer to banks as being conservative, this ‘double security’ concept is a good example of how that actually manifests itself. Now you see why the bank officer was so keen and eager to sup- port your application and add all those initial start-up costs into the loan!

Plenty of people have made plenty of money with property investments, but, plenty of people have not. The standard purchase of a suburban property and then rent it out tends to be the favorite of ‘mum and dad’ investors for want of a better term. Sadly this segment is often influenced by factors other than a critical examination of the deal by conducting a detailed analysis of the financial pros and cons.

Finally, it is also a much-overlooked fact, but all the other possible stakeholders in the transaction – your accountant, your bank/loan broker, your realtor and/or property developer will all derive a benefit when the transaction completes.

Call me silly but why on earth would any of them want to introduce negative consequences to the attention of the investor – of course, they won’t. They will be talking-up the deal right up until you’ve signed on the dotted line!

As always, thank you for reading and please, add any comments below. Homepage

PS There is a lot of individual detail to add to any analysis of an impending financial transaction such as an investment property purchase. In my discussion above, I have used averages and generalized in order to create an overview, which I hope, allows you to get some idea of what may occur should you embark on this type of investment.

There is, and always will be, many varied inputs and therefore I remind you that your research and calculations are the definitive methods of deciding what may be the right path for yourself.