Gearing versus cash flow on an investment property. What is the difference?
We’ve mentioned previously the differences between negative and positive gearing. We also delved into the tools available to boost cash flow to improve this gearing position i.e. loan structures to minimise interest rates and reduce those interest repayments. Crucially important for the avid investor, is understanding the differences of gearing and cash flow.
It is possible to find a rental property that is negatively gearing yet at the same time yield positive cash flow. How?
Tax relief from the Australian Tax Office (ATO) is provided whereby the investor or landlord endures an overall net loss on the property i.e. negative gearing. In any case, where this is true, a net loss that arises will be applied as a tax deduction. Ultimately providing tax relief. Tax offsets against the investor’s total income where there is a total net loss on the rental property, can draw back some of that money by way of a tax refund. In some cases where we include depreciation into the calculations, this can switch a property from one that has negative gearing with negative cash-flow to one that is negative gearing with positive cash-flow.
Depreciation on the building and its contents (Division 40 – plant and equipment), can be deducted as the ATO classifies this as a loss made on the property. However, considering depreciation is a non-cash deduction (merely an on-paper-loss), it provides tax relief without costing the investor a cent, besides the cost of obtaining the report. Merely a dent on the budget when Duo Tax depreciation schedule costs $650 which allows you to depreciate $300,000.00 on the average Australian-built home from a single report!
Example of tax depreciation calculation to indicate gearing and cash flow:
Landlord’s income is $50,000
The tax rate is 30%
Rent: $2,000 per month
Expenses: $1,800 per month (excluding depreciation, includes insurance, interest on loan, rates, and management fees)
Total net loss: – $200 per month
Tax refund entitled to due to loss: $200 x 30% = $60
Total net-loss after refund = – $200 + $60 = – $140
Net loss after all tax offset is $140 and hence is a negatively geared property with negative cash-flow
Now we include a Duo Tax depreciation schedule:
Depreciation on average Australian home: $6,800 p.a. OR $566.67 per month
Tax Refund on $566.67 = $566.67 x 30% = $170
– $140 before refund on depreciation
+$170 refund with tax depreciation schedule
Net cash position is +$30
Depreciation is still considered a loss or an expense and hence still leaves us in a negatively geared position. However, we achieve positive cash flow just by obtaining a depreciation report