Rental yields, depreciation, and capital gains, oh my. Many terms, acronyms, and ideas can feel foreign to those unaccustomed with the nuances of property investment.
One that can trip up both laymen and those in the know is negative gearing.
But, while negative gearing raises many questions and debates, it's a pretty simple concept to understand.
So, what is negative gearing and how does it work? Here are the answers to many of the most common negative-gearing questions.
Simple explanation: What is negative gearing?
Negative gearing can seem complex. However, it’s actually a simple concept when broken down into its two components ‘negative’ and ‘gearing’.
Let’s start with ‘gearing’. Gearing means to borrow money and use that money to invest.
You can use gearing to invest in property, shares, or another vehicle entirely, but this article will focus on property investing.
Now we come to positive and negative gearing.
A positively geared investor is one who is making more from their investments than they are spending to hold them – ergo, the income resulting from their investment is covering costs brought by it, such as interest on a loan or maintenance expenses.
A negatively geared investor, on the other hand, is one who is losing money on their investment. Their interest expenses and other costs are tallying up to more than the rental income they’re bringing in.
How does negative gearing work?
That’s pretty easy, right? Well, it's made more complicated by the tax offset offered to negatively geared investors that goes by the same name.
Bear with me.
When politicians, accountants, or investors talk about ‘negative gearing’, they’re typically referring to the tax offset that many property investors take advantage of.
A negatively geared investor can deduct the total losses they realise from an investment property from other pre-tax income – such as their wages.
By doing so, they can expect to pay less income tax.
Let’s use an example.
Damien has an investment property in Newcastle. He brings in $550 a week in rent, or $28,600 a year.
He bought his property by taking out a $600,000 home loan. He has a 6% per annum interest rate and makes interest only repayments of around $690 per week.
Without considering other costs, like property management fees, insurance, and maintenance, he spends nearly $35,900 to hold his investment.
That means he is at least $7,300 in the red each year on that investment.
However, he also earns $100,000 at his corporate management job. Thus, he would pay nearly $23,000 in income tax in the financial year 2023-24.
That is, unless he negatively gears come tax time.
He can subtract the $7,300 of losses he realised from his investment property from his $100,000 income, leaving him with just $92,700 of taxable income, on which he would pay nearly $20,600 of tax – $2,400 less than he might have otherwise.
See also: Income Tax Calculator
If you’re considering negative gearing, or you’re currently losing money on an investment property and want to see where you might stand at tax time, you might find Your Mortgage’s Negative Gearing Calculator useful.
Does negative gearing make a good property investment?
Of course, Damien is still in the red, even after he reduces his taxable income by the amount he lost on his investment property.
He has just minimised his losses, he didn’t wipe them out entirely.
For that reason, a negatively geared asset is still a cash flow drain.
However, if Damien’s property’s value increases by an average of, say, $10,000 a year, he might be willing to hold onto it despite it costing him more money than it provides.
Not to mention, if he was earning more, he could save more from negative gearing, even if his losses didn’t increase.
That’s because of Australia’s tiered tax system.
The more a person earns, the more tax they tend to pay. Therefore, the more a person earns, the more they might be able to save from negative gearing.
Top home loans available for property investors right now
Whether you’re planning to be positively geared or negatively geared, a competitive home loan could make the difference between a brilliant investment or a poor one.
Here are some of the lowest-rate investor home loans available right now.
| Lender | Home Loan | Interest Rate | Comparison Rate* | Monthly Repayment | Repayment type | Rate Type | Offset | Redraw | Ongoing Fees | Upfront Fees | LVR | Lump Sum Repayment | Additional Repayments | Split Loan Option | Tags | Features | Link | Compare |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
6.19% p.a. | 6.58% p.a. | $2,589 | Principal & Interest | Variable | $0 | $530 | 90% | Featured 90% LVR |
| |||||||||
6.14% p.a. | 6.15% p.a. | $2,434 | Principal & Interest | Variable | $0 | $180 | 80% | |||||||||||
6.19% p.a. | 6.19% p.a. | $2,447 | Principal & Interest | Variable | $0 | $0 | 60% | |||||||||||
6.19% p.a. | 6.23% p.a. | $2,447 | Principal & Interest | Variable | $0 | $595 | 80% | |||||||||||
6.24% p.a. | 6.46% p.a. | $2,460 | Principal & Interest | Variable | $15 | $250 | 60% | |||||||||||
6.29% p.a. | 6.20% p.a. | $2,473 | Principal & Interest | Variable | $0 | $0 | 80% |
Is it better to be positively geared or negatively geared?
Assumably, most investors who purchase property hope to one day be positively geared.
As mentioned above, a negatively geared property might save a person from paying some income tax, but negative gearing can only ever negate losses, it can’t eliminate them.
The highest tax rate a person can typically pay in Australia is 45% – or 45 cents of income tax for each $1 earned.
For that reason, a $10,000 loss can generally offset a maximum of $4,500 of income tax – leaving a $5,500 gap.
On the other hand, it's common for a property investor to be negatively geared for a period of time after they purchase a property.
They assume that, in the years after their purchase, inflation will increase their rental income. Meanwhile, the size of their home loan will likely remain the same or shrink, depending on whether they’re making interest only repayments or principal and interest repayments.
Thus, negative gearing is a strategy used by many on their journey to owning a positively geared property.
Why is negative gearing so controversial?
The fact that negative gearing can negate some of the losses a property investor realises is the exact reason it’s so controversial.
Those who argue against the tax discount say that it makes the property market less fair, particularly to lower income households.
Many believe that, since negative gearing is a more effective strategy for those on higher incomes, it leads them to spend more on property than they otherwise would.
Therefore, investors using the strategy could arguably be driving up the property market, pricing less wealthy Australians out.
Negative gearing has been a political football for decades.
In fact, it was briefly near-abolished in the 1980s.
In more recent times, the Australian Labor Party lost two elections – in 2016 and 2019 – on promises of negative gearing reforms.
Labor now appears hesitant to broach the perceived issue (perhaps understandably), while its major opponent outwardly supports it.
Risks of having a negatively geared property
There are a number of risks surrounding owning a negatively geared property, and most relate back to cash flow.
To be negatively geared means to be losing money, no matter how glittery the term might sound.
If a property investor were to be losing money week-in-week-out on a normal day, what might happen if their rental stream runs dry? Or if they find their property empty for an extended period of time? Or if they have to fork out money for a major and costly repair?
The other risk that runs with negative gearing is its inherently political nature.
While the electorate appears to favour negative gearing now, that pendulum might swing in the future, thereby impacting an investors’ strategy.
And that’s all before considering the risks associated with investing in property to begin with.
Collections: Negative Gearing Property Investment
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