The major principles of negative gearing are listed below :

The first basic premise is to purchase a home with the view that it will increase in value over a long period of time thus giving a capital gain to the investor.

Property investments are long term propositions as the value can rise & fall. 

Most investors purchase investment properties with the view that their profit lies in the capital growth.

The rental returns usually only assist to cover loan interest and running costs

Investment loans are usually geared so the investor gains a maximum taxation benefit.

Three parties assist in paying off an investment loan :

The Tenant, The Tax Dept, The Investor. 

Investors use domestic property as a wealth creation vehicle and as an alternative / addition to their superannuation.

Investment properties are an ideal way of providing income streams during retirement as the rental income rises with the C.P.I.

Most investors seek to build up a portfolio of investment properties, funding them with interest only loans.

At retirement the investor usually sells one or two properties to clear all loans on the remaining properties.

So how does "Negative Gearing" Work ?

Remember purchasing property for its own sake is a great investment, as it offers a traditional return in excess of 7.0 % over the long term.

But please be careful, growth rates rise and fall, and Property is definitely a long term proposition.

Negative gearing involves simply "manipulating" the expenses so they are greater than the income produced by the investment, so that the investment produces a "book" loss. This loss can be subtracted from other income, thus lowering the individuals tax liability. Here is a simple example :

Investment income = $4000 p.a.
Expenses= $6000 p.a.
Loss = $ 2,000
Other Income $60,000 p.a.
Less Loss $2,000
New Taxable Income = $58,000

The common method of manipulating the expense levels is to predetermine what debt ( loan gearing ) should apply to the investment. Put simply, an investor can manipulate his profit / loss levels by varying the amount of loan he takes to secure the investment.

Basically any genuine expense can be offset against the income derived from the investment to produce a loss. Some expenses are as follows :

• Interest on the investment loan
• Real Estate Management Fees
• Strata Levies
• Repairs & Maintenance
• Depreciation on fixtures
• Loan set up costs (over 5 years @ 1 fifth p.a.)
• Loss of Rent Insurance
• Council & Water Rates
• Building Insurance
• Real Estate Letting Fees
• Reasonable Travel Expenses
• Depreciation on Building
• Accountants & Bank Fees
• Telephone, Stationery & Postage

Tip - Section 221D :
An investor can submit a Section 221d form to the Taxation Dept. and receive his/her tax saving each pay period, which improves their cash flow. The Investor's paymaster is usually instructed by the Tax Dept. to decrease their tax payable each pay period. A wise investor would instruct their paymaster to channel these savings directly to the investment loan.

How Does Depreciation Work?

1. Fixtures & Fittings :
Depreciation is the method of writing off wear and tear on assets that are used to produce income. When an investment property is purchased it is the responsibility of the new owner to set a fair market value on the items that he / she intends to depreciate and gain a tax deduction.

Since 26th February 1992, depreciation is only permissible using the diminishing value method.

Outlined below is a list of some common items and their depreciation rates :

Curtains 30%
Carpets 25%
Fluro Lights 20%
Hot Water Systems 20%
Lino 25%
Kitchen Cupboards 20%
Heating Units 25%
Stoves 20%

2. Depreciation of Buildings (Capital Allowance) :
Technically, this is not a depreciation claim but a capital allowance. It is not based on the value of the building, rather the original construction cost of the building. All residential property built between 17/7/1985 & 16/9/1987 qualifies for a capital allowance of 4%. If the building was constructed after 16/9/1987, then the capital allowance is 2.5%. Capital Allowance applies @ 2.5% for forty years at a flat depreciating rate as per the following illustration :

Example of "Capital Allowance" :
Cost of Property ( Building & Land ) = $150,000 (irrelevant )
Land Value = $ 80,000 (irrelevant )
Construction Cost of Building = $70,000 ( relevant )
Capital Allowance = 2.5% of $70,000
Capital Allowance EQUALS $1,750 for 40 years