We hear a lot about negative gearing, but what is it and how can it benefit you if you’re looking to purchase an investment property?
We look at the differences between positive and negative gearing, why investors need to be across it and the impacts it could have on your tax.
Positive and negative gearing – what does it mean?
Gearing is a common strategy used by property investors and it essentially means that you’re borrowing money in order to buy or invest.
Positively geared… is when you borrow to invest and the income you make on your investment is more than the money you’re spending on it. In other words, your tenant’s rent may cover your outgoings, leaving you with a surplus – but be aware that you’ll have to pay tax on this income.
Negatively geared… is when you borrow to invest and the income you make from your investment (e.g. the rent your tenants pay) is less than your interest repayments and the expenses on that property. These might include council rates, fees to a property manager, insurance or general maintenance.
Neutral gearing… occurs when the income you receive on your investment property is equal to your expenses.
How does negative gearing help reduce your tax bill?
Negatively gearing a property can have significant tax benefits for investors.
If a negatively-geared property is up for rent, there may be the potential to claim the interest on your loan repayments. You may also be able to claim other costs as an expense on your tax. The biggest benefit is that any loss incurred from your investment property may be offset against other sources of taxable income. This in turn reduces the amount of tax you pay and may help you reach your financial goals sooner.
At the same time, your property is hopefully accruing in value – so in time, you could enjoy good capital growth and a healthy profit when you come to sell.
However, if you’re making a loss on your investment, you’ll still need to have income from other sources to cover interest repayments and property expenses.
Pros and cons to negative gearing
You may wish to consider negative gearing if:
- You’re a high income earner. You can afford to pay what’s required on the property (including the mortgage payments if you go through periods without a tenant).
- You’re seeking tax offsets. This makes sense if you’re in a high tax bracket.
- You’re investing in a strong market. Investing when the property market is booming can mean good capital growth on your investment in the long-term.
- You’re keen to build equity. You have plans to renovate the property in order to increase its value and build your equity.
You may wish to reconsider negative gearing if you’re a low income earner, are investing in a slow market or are keen to get out of debt. If financial freedom is your goal, a positively geared property may be more suitable so you can maximise your potential income.
Weigh up your options
Although negative gearing can have benefits for your tax, it’s probably not a great idea to choose investments simply because of the potential tax benefits.
Rather, you want to invest after careful assessment of your personal financial circumstances and how comfortable you are with risk. Consider speaking with a financial planner or tax professional who can help you weigh up your options before making a decision that’s right for you.