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Updated IRD Rates
New Bright Line Rule for Residential Properties
Negative Gearing- Pros, Cons, How it Works
Negative gearing is a practice whereby an investor borrows money to acquire an income-producing investment property and expects the gross income generated by the investment, at least in the short term, to be less than the cost of owning and managing the investment. The arrangement is a form of financial leverage. The investor may enter into such an arrangement and expect the tax benefits (if any) and the capital gain on the investment, when the investment is ultimately disposed of, to exceed the accumulated losses of holding the investment.
Taking out a loan to raise money for an investment is a well-used tactic for many New Zealanders. In fact, borrowing to buy big ticket items is part of financial reality — how many of us could afford to buy a house out of our own pocket, for example.
Borrowing funds will increase the amount you can have invested, and naturally amplifies potential gains because there is more of a capital base on which to earn returns. The caveat in all this, of course, is that it can also magnify losses. If you're using borrowed funds, and the investment makes a loss, you are still responsible for the interest on the loan as well as the principal of the loan itself.
A "geared" investment is just another way of saying that the amount invested has been ratcheted up through getting a loan.
One of the basic principles of tax in New Zealand is that costs necessarily incurred in earning income are generally tax deductible. Where a loan is needed to buy an income-producing asset, the interest on the loan is tax deductible.
For investment property, the ideal situation would be to make enough returns to cover loan repayments, plus interest, over the life of the loan. But what if some negative influences crop up? Say interest rates increase, or the tenants move out and leave you with no rent coming in. A longer-term concern would be the property losing value over the time you own it.
A negative gearing strategy makes a profit under any of the following circumstances:
The investor must be able to fund any shortfall until the asset is sold or until the investment becomes positively geared (income > interest).
Should a loss be made on your investment property because its costs exceeds its income, the laws on negative gearing can step in and reduce the impact of that loss by allowing you to offset it against other income — in other words, you can take the loss off your assessable income to end up with a reduced income before tax is calculated. With investment property there are also allowable expenses to be deducted — rates, repairs, depreciation of assets and more.
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