You have probably heard a lot of talk about negative gearing in relation to the property market, particularly property investing. If you’re a property investor, future property investor or just interested in the topic, but aren’t 100 percent sure about what it is and how it works, read on.
Gearing for investment
First of all, the term used when you borrow money to invest is called gearing, and gearing is often referred to in property investment. Gearing can either be positive, negative or neutral. Simply put, these types of gearing reflect the income earned against the money invested. To get a good idea of negative gearing, we’ll touch on all the types of gearing.
Negative gearing
Negative gearing happens when your investment’s income is less than your investment’s expenses. For example, an investment property’s rental income is $26,000 for a financial year. The property’s interest payments and costs for that relevant year are $30,000. Therefore, the investment has made a loss of $4,000, which makes the property negatively geared.
Negative gearing benefits
While negative gearing means that the property has made a loss, in some situations, this can be a benefit. The expenses and other tax deductions you can claim for a property investment can reduce your overall taxable income, such as your salary, business income or other investment income. Particularly for those who have a higher marginal tax rate, negative gearing can be a good solution to offset their overall taxable income.
Negative gearing risks
The benefits to negative gearing can be a great option to turn your overall financial situation into a positive, but it is important to be aware of the risks so they can be minimised.
For example:
- Not having sufficient cash flow can affect your ability to service your debt and meet required financial obligations to manage your property. To avoid this situation, it is important to choose an investment property that is in a prime location where it will be easier to get tenants and hopefully reduce the time the property is vacant, thus ensuring steady rental income. Also, consider if you have the ability to sufficiently cover any shortfalls of your property investment’s financial obligations.
- If the value of your investment doesn’t increase over the time it is held, your investment results in a loss and negative gearing didn’t work. The goal for all property investment is to eventually gain capital, so it is important to choose the right strategy for your situation.
Positive gearing
Positive gearing occurs when your investment’s income is greater than your investment’s expenses. An example of this is when an investment property’s rental income for a financial year is $26,000 and the expenses are $20,000. This results in a profit of $6,000, which means the property is positively geared.
The benefits to positive gearing is that you have higher cash flow and can reduce the size of your loan. However, you aren’t able to minimise the tax payable on your other income.
Neutral gearing
Neutral gearing is when your investment’s income equals to interest payments and other costs, such as rates, maintenance work and insurances. There are no tax implications for neutral gearing, as you neither make a profit or a loss, which means you don’t pay tax and there are also no tax benefits.
Considerations to take when gearing
Choosing the right method of gearing is important to ensuring your profits are maximised. To do this, you can get advice from financial experts to help you understand the options available to you in your situation while taking into account the risks you are comfortable with taking.
- Choose an investment that will rise in value over time
- Rent is reliable and rises overtime
- Cash flow to meet
If you would like to know what you can claim as an expense for an Australian rental property, visit the Australia Taxation Office’s website.
REFERENCES
Australian Securities and Investments Commission, SmartMoney 2017, Negative and Positive Gearing, sourced February 2018, https://www.moneysmart.gov.au/investing/invest-smarter/negative-and-positive-gearing
AMP 2018, What is gearing and how can I use it to invest in property?, sourced February 2018, https://www.amp.com.au/personal/news-education/education/your-questions-answered/what-is-gearing-and-how-can-i-use-it-to-invest-in-property
Australian Tax Office 2017, Expenses you can claim, sourced February 2018, https://www.ato.gov.au/General/Property/Residential-rental-properties/Expenses-you-can-claim/
Commonwealth Bank of Australia 2017, What is negative gearing?, sourced February 2018, https://www.commbank.com.au/guidance/property/negative-gearing-and-tax-201605.html
Mortgage Choice, Negative gearing and positive gearing, sourced February 2018, https://www.mortgagechoice.com.au/home-loans/property-investment/tax-and-gearing/negative-gearing-and-positive-gearing/
RAMS 2016, Negative gearing and its positive results, sourced February 2018, https://www.rams.com.au/calculators-and-resources/knowledge-centre/blog/negative-gearing-and-its-positive-results/
