Negative gearing

When it comes to investing, ‘gearing’ is what happens when you borrow money to buy an asset.

Positive gearing occurs when you make taxable income from your investment.

Conversely, negative gearing is an investment strategy where you essentially borrow money to invest it, and make a taxable loss against that loan. You can then claim this loss as a tax dedication, and reduce the amount of income tax you pay that financial year.

It’s a strategy that medium to high-income earners can use to minimise their income tax liability each year.

Negative gearing is most commonly associated with investment properties. A negatively geared property exists when your rental return is less than the interest on your home loan and all other property-related expenses.

Here’s how it works. Say your investment property receives $25,000 in rent each year, but the ongoing expenses for your property (such as council rates, land tax, water, insurance, interest on your loan, etc) come to $35,000 each year. This means you’re spending $10,000 more than the income you’re generating—you’re essentially losing $10,000. This $10,000 loss is reported on your tax return and claimed as a deduction which reduces your taxable income.

However, it’s important to note that negative gearing only works when you hold the investment within your personal name or jointly in your personal name with other parties.

For this strategy to also work effectively in the long term, you need to ensure the property is increasing in value. If not, you’re effectively creating a loss on your property and your equity position is going backwards.

For example, if you claim a $10,000 loss on your tax return each year for a new investment property, you need to ensure this investment is also increasing in value by at least the same amount to ensure it makes the investment worthwhile.

When a property is negatively geared it’s essentially making a loss, and costing you extra money to hold the investment.

But that’s not all bad. This type of investment approach provides two key benefits:

It reduces your taxable income

Making rental loss on a property effectively reduces your taxable income every year it occurs. So this makes this type of tax offset quite appealing to investors with a medium to high personal income. For example, if your taxable income is at $100,000 for the year, and your rental property makes a $10,000 loss in that same financial year, this means your taxable income is reduced to $90,000.

At this income level you’re taxed at 32.5% on every dollar you earn, so the tax saving made on that $10,000 is roughly $3,250 (excluding any extra tax offsets or other extra liabilities that might be incurred, such as a HELP/HECS Repayment).

Long term wealth gains

Property has been a stable investment within Australia over the last 30-40 years, so there are a lot of benefits in buying an asset that’s initially highly leveraged against a mortgage. Investing in an asset that’s likely to increase in value, means you’re still accruing value within the asset, while using the negative gearing to reduce your taxable income. So you’re effectively building capital, while at the same time enjoying reduced taxable income. The longer you utilise this investment strategy—if your property continues to increase in value—the more value you’ll receive from the income tax deductions.