Understanding Negative Gearing

[NzDuder]

Hello

Im trying to get my head around negative gearing. I've read a number of books and know I will see an accountant about this soon, but thought I'd put this to the forum.

Im in the 39% tax bracket on my day job. I have a two year fixed Interest Only loan(25yr). I'm due to put tenants in my newly purchased property this January07. The rental will just cover the interest on my monthly payments.

If pay a bulk of interest (6months worth) from the loan before 31st March 07 tax year deadline will I get a greater tax rebate ?

Obviously I need to check with the bank , to see if there's any penalty for paying interest early.

Am I way off or is there any sense to my thinking. I would love to hear your comments.

Kind Regards Kiwi

[BusyLizzy]

Hi NZDuder,

Are you also paying off a mortgage on your family home? If yes, then I would suggest that you would want to focus on paying off the family home mortgage first. The interest you pay on that mortgage will not be tax deductible, whereas the interest paid on your rental mortgage will be. First rule (in my opinion) is pay off the family home first.

Regardless of your answer to the above, I don't see how paying off your mortgage early will give you an bigger tax rebate. Having said that, I'm not an accountant. But it does made me question the purpose of your investment - are you merely trying to reduce your tax, or are you trying to achieve cashflow?

If you are after cashflow, then paying down your mortgage will help you achieve that. But some might argue that you would be better to use that spare case to purchase another property.

If you after tax rebates, then get a chattels valuation done at the time you complete the purchase. This will allow you to claim depreciation - but you also need to be aware of depreciation clawback issues if/when you decide to sell.

[RentMaster]

Hi NzDuder

I am not sure if you can pre-pay interest. Pre-paying principle makes sense - it reduces the amount of the loan which you owe. But interest is a bit different. Interest is a bill from the bank which they charge you for the use of their money. I dont know if they can pre-bill you the interest expense in advance.

[spaceman]

It's xmas and I'm too lazy to do the maths ..but

I saw some stuff one time that proved that there was little diference between paying interest in advance or arrears.... the maths was quite long and boring but the diference was small (a couple of percent) and not worth bothering about IMHO

My take on the your idea, is that to get the maximum rebate you must cop the largest possible loss. For this to happen your expenses must be higher than your income. Interest is one of your expenses, if you pay it off early typically you would expect to lower your interest bill (else why would you bother?). If you lower your interest bill you'll lower your expenses and there by lower your rebate..... which is not what you want.

That being said if you can lower your expense so that you income excedes your expenses you will make a profit and be taxed on that ..... a much better situation to be in IMHO

Cheers
Spaceman

[McDuck]

Hi.

Personally I hate the fancy terms people come up with.

Negative gearing…yikes!

May I strip it back to basics?

Really it just means making a deliberate loss.

Why would anyone make a deliberate loss?

Well for example a baker might buy a big bread making oven and the cost of that would make him loose income for say three years.

Even though the oven doubled the production capacity of the baker, it’s cost still made the books look bad annually.

But on the forth year, once the cost of the oven was absorbed, the baker would be in the black and now enjoy a doubled capacity.

Why did the baker not simply save the money and then buy the oven?

Because the money the baker could save in a year was so small that it would take ten years to get enough spare cash for a new oven.

By borrowing the money the baker was able to drag his future prosperity towards him prematurely.

He was able to double his production in three years instead of ten.

What are the risks? ( reward is normally the flipside of risk )

Firstly, during the three years of reduced profit, the baker was in a weak financial position, having a greater risk of loosing his business completely, what say or the other baker on town was able to offer cheaper bread...

Secondly the baker was not enjoying the little luxuries that his surplus was previously paying for…no fancy wine or fancy cheese for him for a while.

This should demonstrate the logical soundness of borrowing to own an asset.

However it’s important to note that there are many other little details and quirks involving the concepts of inflation, taxation, interest and so on, that specifically apply to particular situations.

Possibly the most important observation to make about this whole scenario is the way it is all totally ass about face.

The baker by running his business well and being in tune with his customers and community should generate a surplus of wealth and be stuck for ideas of what to do with it.
This is where his expansion should be driven from.

Hope this helps.
Duck out.

[Wayne]

paying interest early would increase this years loss and thereby enable a greater rebate but ...
what happens next year? Either you have to repay interest early again or have a lower loss and less rebate next year!

I have heard of timing payments to optimise the tax position using things that happen once (timing a big capital purchase etc) but for a regular expense like interest I don't see the point.

[JohnL]

If your accountant is doing their job ethically, then surely it would show as a pre-payment on the balance sheet and wouldn't show on your Profit and Loss statement. It wouldn't technically be an expense relating to that financial year. It could be construed as tax avoidance by trying???

John (ps I'm not an accountant so only my opinion).

[Perry]

Again and again and A Gain . . . .

Personally I hate the fancy terms people come up with.
Negative gearing…yikes!
May I strip it back to basics?
Really it just means making a deliberate loss.
Why would anyone make a deliberate loss?

Jees, haven't we hammered this enough, in earlier threads?
One missing dimension I see in your scenario, McDuck,
is that deliberate loss is using a phrase in a way that
conveys a part-truth. The words we use (fancy terms,
if you prefer), are important, just as the circumstances
are, in which we use them.

There is a difference between a tax loss and a cash
loss. Isn't that what NzDuder is essentially asking?

I can't find the thread, despite an extensive search, but
the point was made that a range of existing costs that
were non-deductible, become deductible once a business
is started. These contribute to deductions, without
increasing expenses and may reduce 39c/$ tax predation.

Found it!
http://www.propertytalk.com/forum/sh...ight=deduction

[McDuck]

I suppose so.

When I think about real gearing in a mechanical device where the trade off is always speed vs. torque…I mean in that root meaning ..well the idea of negative gearing is nonsense.

Friction or inefficiency loss are the words used to describe getting less energy out than was put in.