You may have recently read or heard some arguments in favour of or against negative gearing, as well as its potential benefits and risks. But what exactly is negative gearing, and how might it affect you as a potential property investor?
Positive, negative and neutral gearing
Gearing is when you borrow money to make an investment, and it’s often talked about in regards to investment properties. There are three types of gearing depending on the income earned from your investment: positive, neutral and negative.
Positively geared properties are when the rental return is higher than your interest repayments and outgoings.
Negatively geared properties are when the rental return – the amount of rent you receive from your tenants – is less than your interest repayments and outgoings, placing you in a position of losing income.
Neutral gearing is where you earn the same amount from your investment as you pay in interest and other costs, such as rates, insurance and renovation work.
Can there be advantages to losing money?
This is where it gets interesting for potential investors. According to Australian tax law, you may be able to claim the interest portion of your loan repayments and also some other costs as an expense, providing that the property is available to be rented.
The key benefit associated with negative gearing is that the loss associated with the property ownership may be offset against other income earned, such as your salary, reducing your taxable income and therefore your tax payable.
The result is that the cost of owning the property is being funded by your tenant in the form of rent, by the Australian Tax Office in the form of tax savings, and by your other surplus cash flow, such as your savings and other forms of income.
In certain circumstances, the savings through tax deductions on this loss can exceed the losses realised from the property. It's important to remember, however, that every situation will be different due to personal circumstances.
Some things to know
While negative gearing can have financial benefits, there's often a lot more to investment properties than tax.
The income from positively geared properties, for instance, can help to improve buying power by putting money into your account and can increase your ability to meet repayments.
In general, higher taxpayers may choose a negatively geared investment property to maximise their tax returns and benefit from the long-term capital growth potential.
Investors closer to retirement or in a lower income bracket may choose positively geared investments to maximise their income potential.
As with all investments, strategies should be aligned to personal circumstances and risk preferences.
We recommend talking with your financial adviser before purchasing an investment property.
To find out more about what you can and can't claim on a rental property, visit the ATO's website.